Soaring Prices Push South Korea’s Real Policy Rate to 3-Year, 2-Month Low

Soaring consumer prices have pushed the real policy rate felt by households and businesses in South Korea to its lowest level in three years and two months. The real policy rate, calculated by subtracting consumer inflation from the nominal benchmark rate, has fallen deeper into negative territory, strengthening the case for a Bank of Korea rate increase as lower real borrowing costs can spur lending and boost market liquidity.

Data from the Bank of Korea and the National Data Portal showed on June 3 that the real policy rate based on May consumer prices fell 0.5 percentage point from a month earlier to an annual minus 0.6%. That was the lowest reading since March 2023, when it stood at minus 0.7% as inflation surged in the wake of the Russia-Ukraine war. The real policy rate was derived by subtracting the 3.1% consumer inflation rate from the benchmark rate of 2.5%.

The real interest rate is based on the Fisher equation proposed by US economist Irving Fisher. Central banks and economists use it as a key gauge of whether monetary policy is tight or loose.

The latest decline in the real rate reflects renewed inflation pressure. Consumer inflation reached 3.1% in May, the highest level since March 2024, when it was also 3.1%, marking a high not seen in two years and two months. A 24.2% jump in petroleum prices, driven by the war in the Middle East, led the increase.

The BOK said inflation is likely to remain in the 3% range for the time being as international oil prices stay elevated. If the benchmark rate remains at 2.5%, the real rate will probably stay negative. A negative real rate lowers perceived borrowing costs for households and companies, which can stimulate loan demand. Increased liquidity may also flow into asset markets and deepen financial imbalances. That has added to the rationale for a BOK benchmark rate increase in July.

Kim Ik-hwan, Hankyung.com reporter lovepen@hankyung.com