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Rhee Chang-yong, the governor of the Bank of Korea, takes part in an emergency macroeconomics and finance meeting held in downtown Seoul on Sept. 22. (courtesy of BOK)

“We will keep at it.”

These were the words of Jerome Powell, chairman of the US Federal Reserve, on Wednesday during a press conference shortly after taking the “giant step” of raising the federal funds rate by 0.75 percentage points.

The market paid close attention to Powell’s comment since his words were similar to the title of an autobiography by one of Powell’s predecessors, Paul Volcker: “Keeping At It.” In the early 1980s, Volcker raised interest rates to an unprecedented 20% when the country was at risk of an economic recession.

Powell’s words clearly show his willingness to make an economic “hard landing,” which would include high unemployment, in order to regain control over prices.

South Korea, which is highly dependent on foreign countries, is also being directly impacted by these measures.

The Fed’s hard-line response was also reflected in its economic projections released the same day.

The real economic growth forecast for the US for 2022 was lowered by a whopping 1.5 percentage points from the original 1.7%, resulting in a growth prediction of a mere 0.2% for this year.

The federal funds rate, which is currently at 3%-3.25% per year, is also expected to soar to the high 4% range next year.

“It is difficult for anyone to conclude whether the current situation will lead to a recession, but the possibility that growth below the trend will continue for a considerable period of time is very high,” Powell said.

Meanwhile, Bloomberg concluded that the probability of a recession in the US within the next year is more than 50%, based on market participant surveys and the difference between long- and short-term interest rates (10- and two-year yields).

Regarding the need to overcome inflation, Powell said “I wish there were a painless way to do that. There isn’t.”

He also said achieving the goal of an economic “soft landing” without excessive job losses or too much damage would be “a challenging task.”

In other words, Powell is acknowledging the fact that soaring interest rates are likely to negatively impact growth and could lead to an economic recession where the number of unemployed increases.

South Korea is also not immune to similarly harsh consequences. The Bank of Korea announced its revised growth forecast for this year at 2.6% in August. However, this figure was calculated based on the previous US economic growth outlook, which stood at 1.7% at the time.

But since the US growth rate has plummeted to 0.2%, it has become much more likely that South Korea’s annual growth rate for 2022 will also suffer a significant slash.

“Economic teams including the Ministry of Economy and Finance and the Bank of Korea will respond to the current situation by keeping our eyes on the long-term, broad picture,” said Choo Kyung-ho, Korea’s deputy prime minister and minister of economy and finance, at an emergency economic meeting on Thursday morning.

“We will not only manage short-term volatility but also look for an optimal policy by keeping the trends after next year in mind as well," Choo added.

This suggests that the economy, which had been recovering since COVID-19, could become sluggish and enter a long-term low growth phase.

In reality, South Korea’s economy is facing unfavorable factors both internally and externally.

For one, the key interest rate gap with the US continues to widen and the domestic benchmark interest rate, which currently stands at 2.50% per year, is set to inevitably rise significantly as a result of soaring exchange rates and other factors.

Moreover, if market interest rates rise, domestic demand such as consumption and investment suffer direct hits.

In particular, South Korea’s household debt (based on household credit) rose to a whopping 1.87 quadrillion won as of the end of the second quarter of this year. To make matters worse, with every 0.5 percentage point increase in the interest rate, the annual interest burden is expected to increase by about 6.6 trillion won, thus weighing on consumption.

Exports are also being adversely affected by interest rate hikes in major economies such as the US and EU and the concerns over an economic recession they’ve prompted.

South Korea’s trade deficit from Sept. 1-20 had already reached US$4.1 billion (about 5.8 trillion won), and the current account, which determines external fiscal soundness, is highly likely to record a monthly deficit going forward.

In fact, international organizations and others believe that a slowdown in Korea’s economic growth rate from this year is already a grim reality.

The Organisation for Economic Cooperation and Development, for instance, recently lowered South Korea’s 2023 GDP growth by 0.3 percentage points to 2.2%.

By Park Jong-o, staff reporter

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