Bank of Korea study links KR and US interest rate synchronization to inflation

A report by the Bank of Korea's Economic Research Institute has identified global inflation shocks as the primary driver behind the synchronization of long-term interest rates between South Korea and the United States.

Analysis using the Gaussian Dynamic Term Structure Model (GDTSM) shows that during periods of high volatility, such as the 2008 global financial crisis and the 2021 inflation surge, the long-term rates of both nations moved in close tandem. The study highlights that the transmission of these shocks to South Korean rates occurs more significantly through the ‘policy expectation channel’ rather than the ‘risk compensation channel.’

This means that when US interest rates rise, South Korean long-term rates often follow because markets anticipate that the Bank of Korea will adjust its base rate to match the Federal Reserve's trajectory. The report suggests that while external shocks are inevitable, the Bank of Korea can mitigate the intensity of this synchronization by managing market expectations through more active communication regarding domestic monetary policy.