The central bank of South Korea decided to raise interest rates on Tuesday during the Monetary Policy Board meeting in Seoul. According to the Korea Times, the intervention stops a phase that has lasted about three years and half without increases in the cost of money. The tightness arrives in a different context than before which allowed the institution not to intervene: economic prospects have improved, but price pressures are not returning and there are concerns related to liquidity and financial stability.

The new official rate was set at 2.75%, with an increase of one quarter of percent percentage point. The last increase dated back to January 2023. The decision opens up a new phase of monetary policy of South Korea, even if the Bank of Korea did not indicate a predetermined path for the next meetings nor specified the number or extent of potential future interventions.

To strengthen reasons for tightening is mainly the improvement of expectations on growth. The Korean economy benefits from the expansion of the semiconductor industry, supported by the global demand connected to the boom of artificial intelligence. The chip component, central to the national production system, gave new momentum to the recovery and reduced the need to maintain a more accommodative monetary orientation.

However, the same acceleration also carries risks that the central bank considers relevant. An excessive availability of liquid assets may fuel prices of active and contribute to prolonging inflationary tensions. The combination between greater dynamism of the economy and persistent vulnerabilities to finance has therefore shifted the balance of the decision towards an increase in interest rates, after a long period without raises.

According to the synthesis of the Korea Times, the rise in prices exceeds the target institution since February end, coinciding with the beginning of the conflict described as a confrontation between the United States and Israel with Iran. The persistence of inflation assumes a heavier weight in valuations of the council because the return to 2% does not appear consolidated yet. The strengthening of growth offers the central bank more space to counteract price pressures.

The decision reflects thus two parallel trends: on one side the improvement of economic activity, on the other hand the risk that the demand and liquidity maintenance keep high inflation levels. Shin Hyun-song who opened the Monetary Policy Board meeting left open the possibility of future increases. The governor stated that the central bank will continue to intervene through monetary policy until it is convinced that inflation converges sustainably towards the target.

The indication did not contain deadlines but signaled that the raise at 2.75% might not represent the conclusion of the restrictive phase. A change was noted regarding the imposition maintained after January 2023. In the evaluation of the institution, the support offered by technological recovery does not eliminate macroeconomic risks, but makes urgent to avoid that the strengthening of demand translates into further imbalances.

The monetary policy must therefore measure itself contemporaneously with the expansion linked to semiconductors, above-traguard inflation and possible consequences of abundant liquid assets on markets. The context remains attached significantly to global demand for chips. The boom of artificial intelligence has improved prospects for South Korea, but concentrates an important part of the recovery in a single sector.

Available information does not specify how this momentum can extend to other sectors of economy nor which contribution will be made in coming months to growth. Future decisions depend mainly from price trend, continuity of semiconductor demand and effects of liquid assets on active values. The Bank of Korea must verify if inflation starts to converge stably towards 2%.

The recovery should also conserve sufficient strength during tightening. Uncertainty remains over time and dimensions of potential future increases, which Shin Hyun-song indicated as possible without anticipating calendar.