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This undated photo shows Lee Ju-yeol, governor of the Bank of Korea. (provided by the Bank of Korea)

The era of near-zero percent interest rates, which were adopted in Korea in response to the COVID-19 pandemic, has come to an end after 20 months.

The decision by the Bank of Korea (BOK) to raise the benchmark interest rate to 1% per annum is predicted to increase the annual loan interest for all South Korean households by 5.8 trillion won (US$4.8 billion) compared with late 2020.

Having already raised the rate twice this year, the BOK signaled that an additional hike may come early next year. This is expected to spell a harsh chill for households as their debt — which has swollen to 1.845 quadrillion won, or US$1.5 trillion, collectively — comes back to bite them.

At a meeting of its Monetary Policy Board on Thursday, the BOK raised the interest rate from 0.75% to 1.00% per annum.

Standing at 1.25% just before the COVID-19 pandemic erupted, the interest rate was lowered to 0.75% in March 2020 before dropping to a historic low of 0.50% that May.

But the BOK raised it back to 0.75% in August 2021. With the latest additional hike, it brought the rate back to the 1% level.

The BOK cited trends of improving business conditions, high prices, financial imbalances, and retrenchment in major economies as guiding its decision. According to its predictions, the South Korean economy is poised to record annual growth of 4% this year. The BOK also predicted the rate of increase in consumer prices would exceed the 2% target for price stability by the second half of 2022.

Overheated activity in real estate and the asset market shows no sign of cooling either. Overseas, the US Federal Reserve began tapering (reducing asset purchases) this month, signaling a gradual shift toward retrenchment in monetary policy.

With the two hikes since August, the BOK had raised the interest rate by a cumulative total of 0.5 percentage points. According to its analysis, a rise of 0.5 percentage points in the interest rate translates into an increase of roughly 5.8 trillion won in annual interest on all South Korean household loans compared with late 2020. The average per capita interest burden for borrowers is up to 3.01 million won per year from 2.71 million last year.

By income level, average annual interest payments for high-income borrowers (top 30% in terms of income) have risen from 3.81 million won to 4.24 million won. This segment’s interest burden is high because the scale of borrowing is also high.

For vulnerable borrowers — defined as those who have three or more liabilities and rank in the bottom 30% for income or have a credit rating of 664 points or lower — the average annual interest burden has risen from 3.2 million won to 3.73 million won. While the increase is smaller for vulnerable borrowers when compared with high-income ones, the larger number of people in this segment who have poor credit and loans with variable interest rates means the pain for them is likely to grow.

It also poses a threat for self-employed small business operators with liabilities. The cumulative 0.5-percentage point rise in the interest rate is predicted to translate into an increase of 2.9 trillion won in annual interest payments for all self-employed small business operators compared with last year.

In addition, stiffer regulations from financial authorities mean that commercial banks are raising their own interest rates, which is expected to translate into a higher perceived burden from the interest rate hike than the BOK’s calculations suggest.

Analysts are predicting the BOK’s interest rate hikes will continue going forward.

“We have raised the benchmark interest rate to 1.00%, but that’s still accommodative when compared to trends in economic growth and prices,” noted BOK Governor Lee Ju-yeol, hinting at the possibility of additional hikes to come.

The Monetary Policy Board will not be holding any more meetings this year. In the first half of 2022, it is scheduled to convene in January, February, April and May.

If the BOK does raise the interest rate one more time in early 2022, that would bring the rate back to its pre-pandemic level of 1.25%.

By Jun Seul-gi, staff reporter

Please direct questions or comments to [english@hani.co.kr]