BoK’s monetary policy to tighten even as hiking cycle ends

Even without rate hikes, central banks’ monetary policies can effectively tighten if the nominal neutral rate falls below the policy rate. We expect this will be the case for the Bank of Korea (BoK) this year, as the gap between the policy rate and the nominal neutral rate widens.

What you will learn:

• Based on our estimates, the BoK’s current monetary policy stance is neither overly restrictive nor accommodative. But if the bank holds the policy rate at the current level of 3.5%, easing inflation expectations will likely bring down the nominal neutral rate below the policy rate, implying a more restrictive stance.
• The BoK deems a restrictive policy stance as appropriate at this point, which supports our baseline forecast of an extended pause in the policy rate cycle in 2023. Given the BoK’s focus on inflation, we expect its policy stance will stay restrictive rather than turn accommodative. This will weigh on growth, as reflected in our below-consensus forecast.
• We have identified three reasons why the BoK is likely to stick to a tight policy stance: fears of de-anchoring inflation expectations, elevated private debt, and a hawkish US Fed.