The U.S. Federal Reserve held its Federal Open Market Committee (FOMC) meeting Tuesday and kept its benchmark interest rate unchanged at 3.5% to 3.75%. It marked the fourth consecutive time this year that the Fed has frozen the rate. However, Fed members raised the median projection for the year-end benchmark rate from 3.4% to 3.8%, clearly lending weight to a hawkish stance that a rate hike will take place within the year.
Before the war in Iran, forecasts favoring a Fed rate cut had been dominant, but the mood has shifted this time, with nine of the 18 Fed members projecting a rate hike. Heightened inflation forecasts played a part in the Fed's abrupt pivot toward a rate hike this year. On the same day, the Fed raised its forecast for this year's personal consumption expenditures (PCE) inflation rate by 0.9 percentage point to 3.6%. In contrast, it lowered its forecast for this year's U.S. real gross domestic product (GDP) growth rate from 2.4% to 2.2%. U.S. President Donald Trump, who has been pressuring for a rate cut, expressed strong dissatisfaction with the Fed's rate freeze that day, calling it "hard to believe" and saying that "a rate hike only weighs down the national economy." But the Fed sent a clear signal of a rate hike by adding the phrase that it "will be committed to price stability."
Central banks in major economies are competing to raise benchmark rates and turning toward a tightening stance to stabilize prices. The European Central Bank (ECB) recently raised its benchmark rate by 0.25 percentage point for the first time in three years. The Bank of Japan raised its policy rate to 1% for the first time in 31 years. On top of this, the U.S. Fed's hawkish stance has become even clearer.
It is time for the Bank of Korea (BOK) to prepare preemptively for the possibility that the interest rate gap between Korea and the U.S. could widen beyond the current 1.25 percentage points. First, in step with the global tightening trend, it must prepare a sophisticated policy mix to curb inflation. In addition, because bank lending rates also rise during a period of rate hikes, both households and businesses could face funding pressure, so various measures must be prepared. At a time when the situation is already filled with internal and external instability factors such as high prices, soaring apartment prices, and a high exchange rate, the government's indiscriminate money supply and expansionary fiscal policy could undercut the effects of monetary policy. We must not forget that without painful structural reform efforts, the economy could be left fully exposed to the shock of tightening.
