S.Korea Makes Historic Half-point Rate Hike Amid Over-tightening Fear

South Korea's central bank on Wednesday delivered an unprecedented half-point interest rate hike aimed at pulling inflation back from 24-year highs, but floundering business activity is fast raising fear of a sharp economic downturn.

Record high 1,859 trillion won ($1.42 trillion) household debt and slowing export growth indicate a policy rate widely seen peaking at 2.75% by year-end could add strain to a population saddled with the world's highest debt.

The Bank of Korea (BOK) raised its benchmark policy interest rate by 50 basis points to 2.25%, the biggest increase since the bank adopted the current policy system in 1999, and coming even as the bank forecasts the country's growth rate to lag "below the May forecast of 2.7%".

Twenty-seven of 32 analysts in a Reuters poll expected the bank to announce a half-point hike, while the remainder expected a quarter-point hike.

"Considering inflation and economic conditions, though economic downside risk is indeed high, uncertainties remain elevated, and thus the Board sees it as important at this time to curb the spread of inflation expectations through a 50-basis-point rate hike to prevent acceleration of inflation," the BOK said in a statement.

September futures on three-year treasury bonds rose after the announcement, and were up 36 ticks at 104.97 as of 0303 GMT.

Governor Rhee Chang-yong said successive 25-basis-point hikes look appropriate should the current inflation trend continue, and that he will cooperate with the government to aid households strained by a higher debt repayment burden.

"For those vulnerable facing bigger difficulties, we at the central bank will work with the government to look for targeted policy measures to help them," Rhee said at a news conference.

Wednesday's move keeps the BOK at the forefront of global monetary tightening as inflation threatens to become entrenched for a resource-poor nation grappling with surging energy prices compounded by the war in Ukraine.

The bigger-than-usual hike comes as other major central banks including the Bank of Canada and Reserve Bank of New Zealand delivered outsized hikes in recent weeks, including a third successive half-point hike by the latter on Wednesday.

The U.S. Federal Reserve last month raised its key rate by 75 basis points and is widely expected to carry out similar-sized moves.

In South Korea, the BOK is defending against threats on multiple fronts. Loans taken out by small businesses that are classified as 'vulnerable,' or at risk of default, increased 30.6% from the end of 2019 through March 2022, and the BOK sees the proportion increasing sharply after 2023.

Exports in June grew at their slowest rate in 19 months, further fuelling concern about the economy.

"The BOK needs to pay more attention to the household debt situation just as it tries to tame inflation. At the same time, exports are dwindling for this trade-dependent nation," said Societe Generale economist Oh Suk-tae.

Wednesday's hike could also help curb weakening of the won after the currency tumbled 9.4% against the U.S. dollar this year, making it one of the worst performers among emerging markets.

Most analysts see South Korea's policy rate reaching 2.75% by the end of this year, up from 2.25% in the May poll.