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Jerome Powell, the chairperson of the US Fed, holds a press conference on May 4 issuing its FOMC statement. (EPA/Yonhap News)

In order to cope with the worst inflation in 40 years, the US Federal Reserve raised its benchmark interest rate by 0.5 percentage points to reach 0.75%-1% for the first time in 22 years.

The Fed also hinted at the possibility of increasing the benchmark rate by another 0.5 percentage points in future meetings. As a result, the Bank of Korea’s additional rate hike is likely to come sooner than expected, possibly during its next Monetary Policy Board meeting on May 26.

Expectations for the recovery of the global economy, which was expected to be led by a boom in consumption after the COVID-19 crisis, are now fading while concerns are growing over an economic slowdown caused by interest rate hikes.

At the end of the two-day Federal Open Market Committee (FOMC) meeting on Wednesday (local time), the Fed announced that it would raise the target range for the federal funds rate by 0.5 percentage points to 0.75%-1%. It is the first time since May 2000 that the benchmark interest rate has been raised to double the usual range of 0.25 percentage points.

Back in March, the Fed had already raised its benchmark interest rate by 0.25 percentage points for the first time since 2018. However, with inflation becoming more serious, the Fed decided to take the “big step” of a 0.5 percentage point increase this time.

“Inflation is much too high,” said Jerome Powel, chairperson of the Fed, at a press conference. “And so we need to do everything we can to restore stable prices. We'll do it as quickly and effectively as we can.”

“There's a broad sense on the committee that additional 50 basis increases [0.5 percentage point increases] should be on the table for the next couple of meetings,” Powell added. The announcement provided relative clarity regarding the scope of the additional interest rate hikes, indicating the Fed’s willingness to defeat inflation expectations as its means of monetary policy.

The Federal Reserve also signaled its intention to reduce the roughly US$9 trillion stash of assets accumulated as a result of the country’s COVID-19 economic countermeasures.

The “quantitative easing” policy is aimed at “quantitative tightening” of collecting market cash while reducing US government bond assets purchased by the Fed. The Fed’s balance sheet would be allowed to decline by $47.5 billion per month in June, July and August and by up to $95 billion per month starting in September.

Further interest rate hikes seem increasingly inevitable in Korea. This is because, if the US benchmark interest rate is higher than that of Korea, an “interest rate reversal” and an outflow of investment funds could occur and the value of the won could fall.

So far, the gap between the benchmark interest rates in Korea (1.50%) and the US (0.75%-1.00%) has narrowed significantly to 0.50-0.75 points.

If the Fed takes two or three more “big steps” like this, US policy rates could reverse to a higher level than that of Korea. Goldman Sachs presented a scenario in which the Fed would reduce the increase to 0.25 percentage points after additional interest rate hikes in May, June, and July, resulting in the US benchmark interest rate reaching 3% to 3.25% in the second quarter of next year.

As such, the Bank of Korea’s Monetary Policy Board’s rate hikes are likely to accelerate. This is because it will have to respond not only to the Fed’s additional “big step” but also to inflationary pressure, which has soared to nearly 5% in the country. Moreover, if the US benchmark interest rate rises higher than or close to that of Korea, inflationary pressure due to the depreciating won will increase even more.

“The outflow of capital depends not only on interest rates but also on various variables, so it cannot necessarily be said that outflows occur quickly,” says Rhee Chang-yong, the new governor of the Bank of Korea. “The widening interest rate gap will depreciate the won, and we should be a bit more concerned about its impact on prices.”

At a meeting of the Monetary Policy Board in April, many committee members expressed the view that the market's currency volume should be rapidly reduced to preemptively block the "secondary effects” of further fueling inflation.

The market expects the board to raise interest rates three or four more times within the year, including when they convene in a few weeks’ time, following the April 0.25 percentage point hike.

According to the Bank of Korea, the results of this FOMC meeting were largely in line with expectations while also adding that Powell’s remarks were less aggressive, in terms of the pace and breadth of monetary tightening.

However, the bank added that “the possibility of increased volatility in the financial market remains due to the high inflation situation in the US and the prospect of a continuous 0.5 percentage point hike by the Fed.”

The key is how quickly the policy rate hikes by central banks in major countries such as the US and South Korea, which have been unprecedentedly rapid and high this year, will have an effect on reining in global inflation.

The low prices that dominated the global market for the past 20 years have ended in an instant, and we are now entering an era of inflation.

A growing number of analysts are saying that domestic and foreign economic conditions have changed on a structural level, such as in the reorganization of the global supply chain order, while the traditional interrelationship between economic variables such as price, currency, and growth has also been weakening due to the COVID-19 pandemic.

As a result, the ability of monetary policy to respond as a means of price stabilization has been put to the test for the first time in decades.

By Cho Kye-wan, staff reporter; Lee Bon-young, Washington correspondent

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