South Korea becomes first big Asian economy to raise interest rates

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South Korea has become the first big Asian economy to raise interest rates since the start of the coronavirus pandemic, as record household debt and rocketing property prices outweighed fears over Seoul’s struggle to contain the virus’s Delta variant.

In a closely watched decision on Thursday, the Bank of Korea raised its benchmark rate to 0.75 per cent, increasing the seven-day repurchase rate 25 basis points from a record low of 0.50 per cent.

South Korea is on track for gross domestic product growth of 4 per cent this year. The export-led economy has benefited from robust demand for electronics products including computer chips and smartphones, as well as recovering markets for Korean-made ships and cars.

But economic planners in Seoul have grown increasingly concerned that chronic problems in the domestic economy have been masked by the booming export recovery, which helped rescue the country from the depths of a pandemic-induced recession last year.

“The financial stability issues troubling the BoK continue to build,” said Alex Holmes, an economist with Capital Economics.

“House prices rose by 14.3 per cent year on year in July, the most since 2002. Recent data show that household debt was up by 10.3 per cent year on year in [the second quarter], after posting its largest ever gain in the April-to-June period.”

“With the policy rate still very low by past standards after today’s hike, the BoK will likely want to tighten further to clamp down on financial risks,” Holmes added.

There were also signs that many self-employed workers in Asia’s fourth-largest economy, who make up almost one-third of the labour force, were under mounting financial pressure after their incomes were reduced sharply owing to coronavirus restrictions. 

Economists have warned that despite record government stimulus measures, which have included cash payments, the recovery in consumer spending remained fragile.

Ahead of the decision, economists were broadly split on the BoK’s move despite the bank’s signals to resume rate increases, according to Bloomberg and Reuters polls.

The uncertainty stemmed from a months-long resurgence of coronavirus cases, which has forced South Korea into its toughest social distancing controls since the start of the pandemic.

Doubts were fanned after New Zealand’s central bank last week delayed its planned interest rate rise after a Covid outbreak sparked a nationwide lockdown.

The Won weakened 0.2 per cent to Won1,168 against the dollar following the central bank’s move.

Additional reporting by Hudson Lockett in Hong Kong