Nomura: Korea’s Rate-Hike Risk Rises, but Baseline Remains Hawkish Stance

Overview

This report focuses on the monetary policy direction of the Bank of Korea (BOK). During his attendance at the ADB Annual Meeting and ASEAN+3 Finance and Economy Ministers’ Meeting in Uzbekistan, BOK Deputy Governor Yoo Sang-dae signaled that the central bank might start considering rate hikes. Nomura believes this reflects both rising inflation risks and stronger-than-expected economic growth, shifting the policy focus toward price stability. However, the institution maintains its baseline scenario of ‘extending the hawkish stance,’ merely raising the probability of rate hikes in the third quarter from 15% to 40%.

Core views

The report suggests that the Bank of Korea’s May meeting (May 28) could send out a more hawkish signal, reflecting its relatively optimistic view on growth prospects and leaving room for potential rate hikes in the second half if needed. Two main factors are driving the heightened expectation of rate hikes: first, the Middle East conflict could become prolonged, raising inflation risks; second, South Korea’s strong GDP performance in the first quarter, coupled with a resilient semiconductor cycle, is shifting policy attention more toward price stability. However, Nomura emphasizes that the actual threshold for rate hikes remains high. First, the sustainability of the strong growth in the first quarter remains uncertain: April’s high-frequency data show an average year-on-year decline of 12.3% in fuel sales, consumer confidence falling below 100, and exports contracting by 17.7% year-on-year, indicating that the impact of high oil prices has begun to show. Second, medium-term inflation expectations remain broadly stable: the three-year inflation forecast stayed at 2.6% in March and April, though the one-year inflation forecast rose to 2.9% after the outbreak of the conflict. Therefore, despite the relatively strong growth data in the second quarter, Nomura believes that the upcoming growth figures will still be insufficient to justify premature rate hikes. Based on these judgments, the report maintains the baseline scenario of ‘extending the hawkish stance until the end of 2027,’ keeping the terminal interest rate at 2.50%; meanwhile, given the rising risk of rate hikes in the second half, it raises the probability of rate hikes in the third quarter (July or August) from 15% to 40%.

Analysis framework

Nomura’s analysis follows the “growth—inflation—policy response” framework: first identifying the trigger—the change in central bank officials’ statements—then assessing evidence supporting both rate hikes and rate cuts, and finally expressing the balance between the baseline scenario and tail risks through probabilistic methods. Specifically, the institution views the BOK deputy governor’s public remarks as a policy signal, verifies the sustainability of growth resilience using high-frequency data such as inflation expectations, export volumes, consumer confidence, and fuel sales, and adjusts the probability of rate hikes in the third quarter to reflect changes in risk appetite.

Methodology notes

• Macroeconomic frameworkTaylor rule

  Central bank policy interest rate responding to deviations of economic growth and inflation from their targets

  The report implicitly uses a Taylor-rule-like approach: when actual growth exceeds potential and inflation pressures rise, the central bank faces greater pressure to raise rates; otherwise, it keeps rates unchanged. The institution compares the strong growth in the first quarter with subsequent weaker high-frequency data to determine whether rate hikes are truly ‘necessary.’

• Cyclical and Economic FrameworkBusiness Cycle Turning Point Analysis

  Using high-frequency data to judge whether strong economic growth is sustainable

  The report uses high-frequency indicators such as April fuel sales, consumer confidence, and export volumes to assess whether the strong growth in the first quarter was just temporary—a common practice in business-cycle turning-point analysis.

• Quantitative/Factor/Portfolio TheoryBehavioral bias analysis

  The interplay between central bank signals and market expectations

  The institution interprets the BOK deputy governor’s remarks as part of policy communication, focusing on how he manages market expectations by signaling the possibility of rate hikes rather than taking immediate action.

Key data

• Probability of Rate Hikes in Q340%Raised from 15%, reflecting increased tail risk of rate hikes in the second half
• Terminal Interest Rate Forecast2.50%Under the baseline scenario, the stance remains unchanged until the end of 2027
• April Fuel Sales YoY-12.3%Average year-on-year decline over the past two weeks, showing the impact of high oil prices
• April Consumer Confidence IndexBelow 100Fell from previous levels, reflecting weakening consumer confidence
• April Export Volume YoY-17.7%Indicating external demand pressure
• Three-Year Inflation Expectation2.6%Remained unchanged in March and April; medium-term inflation expectations remain stable
• One-Year Inflation Expectation2.9%Rose after the outbreak of the Middle East conflict

Impact & implications

The report suggests that the Bank of Korea may send out a more hawkish signal in May but won’t immediately raise rates. This means that in the short term, Korean government bond yields and the won exchange rate may be supported by hawkish expectations; however, if subsequent economic data weaken, the market could revise its rate-hike expectations again. For South Korea itself, the prolongation of higher interest rates will put sustained pressure on consumer credit, the real estate market, and corporate financing costs. Although export-oriented industries like semiconductors benefit from the cyclical upturn, uncertainties in external demand still need close attention.

Risks

• The strong growth in the first quarter may be only temporary; weaker subsequent activity data will undermine the basis for rate hikes
• A prolonged Middle East conflict could further increase inflation risks
• If short-term inflation expectations continue to rise, medium-term inflation expectations could become unanchored

What to watch

• The Bank of Korea’s Monetary Policy Committee meeting statement on May 28
• Whether subsequent activity data (consumption, exports, industrial production, etc.) will be strong enough
• Changes in inflation expectations, especially whether the three-year forecast remains stable
• The progress of the Middle East conflict and its transmission to oil prices and South Korean inflation