US neutral rate to exceed 4% in H2, Hyundai Research warns of tightening shock

The Hyundai Research Institute projected Sunday that the US equilibrium interest rate will surpass 4 percent in the second half of this year, warning that South Korea must prepare for a potential tightening shock from the United States.

According to a report the institute released Sunday, the US equilibrium interest rate for the second quarter of this year stood at 3.82 percent annually, already exceeding the Federal Reserve's current benchmark interest rate target range of 3.50 to 3.75 percent.

The equilibrium interest rate is the theoretical rate at which the economy can return to its potential growth level without inflationary or deflationary pressure.

The institute estimated the equilibrium rate using the Taylor rule.

It projected the rate would rise to 3.97 percent in the third quarter and reach 4.09 percent in the fourth quarter.

"This is consistent with the direction signaled by the Federal Open Market Committee, which recently indicated through its dot plot the possibility of a rate hike within the year," the institute said.

The US equilibrium rate is forecast to peak at 4.17 percent in the first quarter of next year before edging down to 4.07 percent by the fourth quarter as inflation gradually stabilizes.

Given the rising likelihood of a US rate hike, the institute said South Korea should proactively prepare for a potential tightening shock from the United States.

"A US benchmark rate hike is likely to drive up global demand for the dollar, amplifying strong-dollar pressures and triggering capital outflows by foreign investors, which could significantly increase exchange rate volatility," the institute said.

The institute added that policymakers need to maintain foreign exchange reserves at an adequate level and, over the longer term, coordinate currency swap arrangements with major reserve-currency countries to strengthen the safety net in the foreign exchange sector.

The institute also expressed concern that a US rate hike could influence South Korea's own benchmark rate decisions, acting as a drag on domestic demand.

"Policy efforts should run in parallel to improve the operating conditions and strengthen the fundamentals of domestically oriented businesses — including by providing policy financing and capital investment support to competitive companies," the institute said.