The ultra-low interest rate era has officially ended after the U.S. central bank finally positioned itself for a full lift-off away from the zero percent range it had kept up for the last decade, sending cold chills across the Pacific and dampening already-feeble domestic demand in Korea as all-time high private sector debt would keep consumer spending to minimal and further slow the economy.

The bellwether Fed action won’t immediately send the Bank of Korea to follow suit as rejuvenated economic and inflationary signs are limited to the United States among advanced markets and conditions in Korea are delicate with the economy sinking deeper into a slump amid political insecurity following legislative impeachment against the president.

Tightening in the United States is feared to speed up as data shows full employment and inflation nearing the 2-percent long-term goal. The U.S. recovery would gain more momentum when incoming Donald Trump administration carries out its ambitious stimuli agenda of tax cuts and infrastructure spending.

On Wednesday, the U.S. Federal Reserve raised its benchmark interest rate by a quarter of a percentage point to a range of 0.5 percent to 0.75 percent and hinted of three more hikes throughout next year.

Local markets inevitably would be shaken if foreign capital pulls out to chase safer U.S. assets that now offer greater interest and foreign exchange rate returns.

Even if the local central bank stays tough to keep the base rate at record-low level of 1.25 percent in support of the economy, it may have to take policy actions if it cannot contain the runaway market yields.

The most dreaded could happen - the bursting of the household debt bubble. Household debt has been refreshing historic highs monthly this year to reach over 1,300 trillion won ($1.1 trillion).

Interest burden would increase as the majority of household and business’ short-term debts are in floating rates. The outstanding balance of floating-rate mortgage loans amounted to 544.4 trillion won as of the end of September, accounting for 58.5 percent of the entire mortgage loans. Some mortgage loans already charge interest of 5 percent.

“Market yields could go higher for sometime regardless of the policy rate,” said Kim Cheon-ku, a researcher at the Hyundai Research Institute. The benchmark 10-year government bond yield has gained 31.4 percent since Nov. 9 when surprising victory of Donald Trump in U.S. presidential election triggered jump in bond yields. It ended Thursday 6.5 basis points higher at 2.196 percent following the Fed hike news and BOK decision to keep its policy rate unchanged at 1.25 percent for December.

According to a BOK report, 1 percent rise in interest rate would sharply increase the over-indebted population to 1.43 million households from 1.34 million.

Financial authorities plan to expand the budget for financial programs for low-income individuals to help them refinance their high-interest loans from 5.7 trillion won this year to 7 trillion won next year, but that action would hardly stop shriveling in consumption.

Higher interest rates also could directly hit the construction sector whose debt-financed spending remained the sole private-sector investment to buffer further contraction in domestic demand throughout this year.

“Housing market slump on top of higher loan cost for construction companies could wreck domestic demand,” said Koh Jong-wan, chief of the Real Estate Management Research Institute.

State-run think tank Korea Development Institute estimated 2017 growth would stop at 2.4 percent, but it may have to downgrade further as it had not factored in latest political insecurity and developments in the U.S. The central bank and government are also expected to revise down economic outlook for next year in their forecast later this month.

“But removal of uncertainties about when the U.S. tightening will take place could bring about stability in the financial markets that had been fretting about higher interest rates ever since the last hike in December last year,” said Seo Jeong-hoon, an analyst at KEB Hana Bank Institute.

Another silver lining is that dollar strengthening would help price competitiveness of Korean products and improve exports next year, experts said.

By Chung Seok-woo and Park Yoon-ye

[ⓒ Pulse by Maeil Business News Korea & mk.co.kr, All rights reserved]