The Bank of Korea has raised its outlook for this year’s economic growth rate to 3.0 percent, which is higher than market expectations. But it has decided to keep its key interest rate unchanged at 1.25 percent. While the rate has been frozen for 16 consecutive months, a dissenting call for a rate hike signals a possible rate increase in the future. Here is Dr. Kim Wan-joong of the Hana Institute of Finance to discuss how the central bank’s Monetary Policy Board assessed the Korean economy and what kind of monetary policy it presented on October 19. First, Dr. Kim analyzes the background for the upward revision for the 2017 growth rate.

The Bank of Korea raised its growth forecast for this year to 3 percent from the previous 2.8 percent that was projected in July, citing some positive indications that exports and facilities investment have remained firm and private consumption has also picked up moderately. The 3 percent growth outlook is in line with the forecasts by the government and the International Monetary Fund. The recent upward revision reflects improvements in exports led by some industries, including semiconductors, until the third quarter, more investment in those sectors, and an extra budget that was not taken into consideration in the July projection. Still, there are concerns about a possible shift in the real economy due to risks related to North Korea, the ongoing trade feud with China over the deployment of an American anti-missile system in South Korea, and a slowdown in the construction sector. With these concerns in mind, the bank kept its outlook for next year’s growth rate unchanged at the previous projection of 2.9 percent.

The central bank raised its growth outlook to 2.6 percent in April and 2.8 percent in July. And it has revised up its forecast again to 3.0 percent. It marks the first time since 2010 that the growth rate has been upwardly revised three times in a year. The negative impact from the dispute over the Terminal High Altitude Area Defense, or THAAD, anti-missile system is projected to cut this year’s growth by 0.4 percentage points. But the continued recovery of the global economy, stronger-than-expected exports, and the effect of the government’s extra budget contributed to lifting the growth outlook. Unlike the successive upward revisions for the growth forecast, the bank’s key interest rate still remains unchanged.

The Monetary Policy Board kept its key interest rate steady for 16 months in a row since June last year. The bank has decided to freeze the rate again, considering continued market uncertainties triggered by North Korea risks, the possibility of unfavorable trade conditions involving the U.S. and China, and the need to curb inflation pressure from the demand side. While the trend of economic growth has continued, exports and investment are only led by particular industries. Therefore, it’s hard to say that the economy on the whole has entered an expansion phase. The actual growth remains at the level of its potential, and the minus GDP gap has yet to decrease. Due to these factors, the bank was hesitant about raising its key interest rate.

The Bank of Korea has not made any changes to the policy rate since it last cut it by 0.25 percentage points in June last year. With geopolitical risks related to North Korea adding volatility to the local markets, heavy household debt that is nearing 1,400 trillion won, or about 1.2 trillion US dollars, is also placing a burden on an interest rate increase. This pressure rose further after a member of the Monetary Policy Board called for a rate hike of 0.25 percentage points.

It is the first time in six years that a member of the monetary board has made a dissenting call for a rate hike. This implies that the central bank is ready to reduce the extent of monetary easing gradually by raising the benchmark interest rate. Even before the recent board meeting, there had been constant calls for lifting the rate to ease financial imbalance. Given the anticipated additional rate hikes by the U.S. Federal Reserve, a future rate increase in Korea is widely expected. But after a rate increase, additional hikes or the timing might change in consideration of economic indexes, as well as internal and external financial environments. In anticipation of a coming key interest rate hike, there is upward pressure on market interest rates.

The last dissenting call for a rate hike took place in September 2011. The latest one, along with the revision of the economic outlook, is interpreted as a sign of a rate increase in the future. Bank of Korea Governor Lee Ju-yeol has once again suggested the possibility of a rate hike, signaling that the bank will soon increase the rate. Korea is worried about a reverse of the interest rate gap between Korea and the U.S. As U.S. Federal Reserve Chair Janet Yellen has suggested, it is highly likely that the U.S. will raise its key interest rate within the year. If Korea keeps its rate unchanged, a higher U.S. rate may prompt a flow of capital out of the Korean financial market.

It is possible that the Bank of Korea will lift its interest rate in the first quarter of next year. Following another rate hike in December, the U.S. Federal Reserve hinted at raising its key rate three times next year. Accordingly, Korea will find it hard to hold its benchmark rate at the current level for fear of a widening rate gap between Korea and the U.S., and possible foreign capital outflow. Governor Lee’s term will end in late March next year, raising the possibility of a rate hike sometime in the first quarter. But the bank will be careful in deciding on the timing of the hike, considering various factors such as how to address a slowdown in the housing market and the construction industry, and how to reduce financial imbalance following real estate regulations and household debt measures.

It is uncertain exactly when the Bank of Korea will raise its interest rate. Given the possibility of a reverse in the rate gap, it may take action in November, one month before the U.S. Federal Reserve lifts its rate in December as largely expected. But the Korean economy faces a number of variables for now, including North Korea risks. Also, the central bank set a precondition of “clear signs of growth” for a rate increase but the signs have yet to appear. If the U.S. hikes the rate in December, Korea may possibly follow suit early next year. The Bank of Korea has obviously sent a strong signal of an interest rate hike, but it also has to consider the U.S. rate increase, North Korea-related risks, and rising household debt.

In addition to its interest rate hike in December, the Federal Reserve will gradually reduce the reinvestment of principal payments from its securities holdings. The move will trigger an interest rate increase around the world. But the Bank of Korea has to take various problems into consideration, including the contraction of the real economy from the prolonged security risk, and snowballing household debt that is nearing the stage of even threatening economic growth. Therefore, Korea will inevitably adopt austerity measures gradually, rather than adjusting the policy preemptively, in keeping with policy changes in central banks in major economies, including the European Central Bank. To minimize the so-called tipping effect in the market in the process, it is necessary to promote communication with the market and take a data-dependent approach when carrying out policies.

While Korea is in an era of an unprecedentedly low interest rate, the global economy is getting away from the trend. The nation should minimize the impact from a possible rate hike by making full preparations while still keeping pace with the world economy.