Asia Markets

South Korea Hikes Interest Rates, the First Developed Economy to Do So in Pandemic Era

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  • South Korea's central bank raised interest rates on Thursday by 25 basis points to 0.75%.
  • That made it the first developed economy to hike rates in the pandemic era.
  • Analysts pointed to financial risks pressuring the economy, such as heating up house prices and rising household debt.

South Korea's central bank raised interest rates on Thursday in a decision that was expected as financial risks heat up despite the virus threat.

The Bank of Korea raised its policy rate by 25 basis points to 0.75% for the first time in nearly three years, becoming the first developed economy to raise interest rates during the pandemic era.

Bank of Korea Governor Lee Ju-yeol said the decision to hike rates was not unanimous, and there was a dissenting board member calling for rates to be held steady. It was also divided among analysts polled by Reuters, with only 16 out of 30 expecting the rate hike on Thursday.

One analyst, Alvin Tan, head of Asia FX strategy at RBC Capital Markets, called it a "grudging rate hike," even though the market was "fully expecting a string of rate hikes."

South Korea's benchmark index Kospi fell 0.18% following the announcement. The Korean won weakened.

Most central banks globally have slashed rates to record lows in a bid to prop up their pandemic-hit economies. From the U.S. to Europe and Asia, governments around the world have been rolling out stimulus measures to support businesses. 

"Admittedly, the virus remains a headwind to the recovery," Capital Economics said in a note following the announcement.

South Korea has been grappling with high numbers of Covid cases in recent weeks, with its rolling 7-day average daily cases surging past 1,800 — compared to just over 400 in June, according to our World in Data.

Last week, the country extended its social distancing curbs for another two weeks as Covid cases surged, according to Reuters.

"But the economy has become increasingly resilient to outbreaks and rapid progress on vaccines should help the country move to more light-touch containment measures soon," Capital Economics said.

The research firm pointed to financial risks pressuring the economy, such as heating up house prices, which rose by 14.3% year-on-year in July. Household debt also shot up, by 10% year-on-year in the second quarter.

James Lee, chief economist of Japan and Korea at HSBC, said he wouldn't rule out further tightening.

"Financial stability risks — household debt rising, housing prices, have been an issue not only this year, not only last year, but at least for the past five years. So when given the chance ... the Bank of Korea will continue to normalize policy rate," he told CNBC's "Squawk Box Asia" on Thursday.

The central bank will "keep the door open for further policy action," he added. "But whether they actually can hike or not will heavily depend on the growth outlook going forward," Lee said.

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