Global Rate Outlook Echoes Covid Tightening; Will South Korea Also Hit 3.5%?

Debate grows over terminal rates as countries extend tightening

Australia's policy rate rises above its Covid-era peak

Some in the market see South Korea's terminal rate at 3.75%

'It depends on growth and inflation at home'

August output, investment and consumption all decline

Australia's central bank has raised its benchmark interest rate above the level reached during the Covid-era tightening cycle, the first such case among major economies. As expectations build for a higher Federal Reserve terminal rate, attention is turning to whether South Korea's policy rate could also rise above the 3.50% peak reached during its own Covid tightening phase.

Norway's rate also reaches its Covid-era level

The Reserve Bank of Australia raised its benchmark rate by 25 basis points to 4.60% from 4.35% on September 29. That took it above the 4.35% peak reached during the post-pandemic withdrawal of emergency liquidity. The move reflected persistent inflation pressure stemming from higher oil prices linked to the Middle East war and rising housing costs. Norway's central bank also raised its policy rate to 4.50% from 4.25% on September 24. That matched the peak from the Covid-era tightening cycle, and the bank left open the possibility of another increase.

Debate is also intensifying in South Korea's bond market over the terminal level for the Bank of Korea's policy rate. Until recently, many in the market had expected the benchmark rate would not rise above the 3.50% peak reached during the Covid tightening cycle. The reasoning was that inflation, even with the Middle East war and a semiconductor boom, would be unlikely to surpass the 6.3% peak seen during the pandemic.

That view has started to shift as expectations spread that the Fed's terminal rate could rise to 4.5%. Market rates have partly reflected the possibility that South Korea's policy rate could climb to 3.75% if US rates move higher.

So far, JPMorgan is the only domestic or foreign securities firm or bank to put South Korea's terminal policy rate at 3.75%. Still, Yoon Yeo-sam, head of equity strategy at Meritz Securities, said the risk of South Korea's rate being pulled up to 3.75% could come into sharper focus if concern grows that the Fed will raise rates above 4.5% next year. Lee Nam-kang, senior researcher at Korea Investment Holdings, said the benchmark rate could rise into the 4% range by the second half of next year or the first half of 2028.

Domestic growth and inflation are key

Many analysts say the terminal rate will depend more on South Korea's domestic growth trend and underlying inflation path than on the extent of US tightening. Even if the rate gap with the US widens, the won is unlikely to surge immediately.

In the near term, the key data point is the September consumer price index, due on October 2. The market consensus is 2.9%. That would still be high, but the comparison is skewed by the Chuseok holiday falling in September this year versus October last year. The Bank of Korea has yet to see a clear sign of demand-side inflation pressure stemming from a semiconductor boom. Statistics Korea said on September 30 that the all-industry production index fell 1.3% from a month earlier to 118.7 in August, marking a second straight monthly decline after a 0.1% drop in July. Fewer working days during the vacation season and production disruptions caused by a Hyundai Motor strike were among the factors.

Retail sales, a gauge of goods consumption, fell 1.8%, extending declines to a second month. Sales of durable goods such as passenger cars dropped 4.5%, while nondurable goods including food and beverages fell 1.6%. Facility investment also tumbled 9.5%.

Choi Ji-wook, a managing director at State Street Markets, said he was leaving open the possibility that the terminal rate could rise to 3.50%, but that it was too early to forecast 3.75% or higher. The Bank of Korea will likely raise rates once more in November, then assess oil prices, the housing market and demand-side inflation pressure before deciding whether further hikes are needed, he added.

Shim Sung-mi, Hankyung.com reporter smshim@hankyung.com