Bank of Korea Likely to Maintain 0.5% Base Interest Rate in 2021

Easing Monetary Policy Expected to Continue Until Economic Recovery from COVID-19 Contraction

Lee Ju-yeol, Governor of the Bank of Korea [Photo by Yonhap News]

[Asia Economy Reporter Eunbyeol Kim] In 2021, the Bank of Korea is likely to maintain the base interest rate at around 0.50% per annum. This is because it has repeatedly stated that it will maintain an accommodative monetary policy until the economy, which has been contracted due to the COVID-19 pandemic, shows signs of recovery. The fact that the United States Federal Reserve (Fed), a key currency country, has announced it will keep the base interest rate at zero until the COVID-19 recovery is another reason why the Bank of Korea is expected to keep the base rate unchanged. Experts anticipate that the U.S. will maintain its base interest rate through 2023.

Governor Lee Ju-yeol of the Bank of Korea stated in his New Year's address on the 1st, "Although the domestic economy is expected to recover gradually, there is high uncertainty regarding the growth path, and the inflation rate is expected to remain below the target level for a considerable period." He added, "Monetary policy needs to maintain an accommodative stance until our economy is projected to continue on a stable recovery path."

The Bank of Korea targets an inflation rate of 2%. Since the annual consumer price inflation rate has remained in the 0% range for two consecutive years, it is the Bank’s responsibility to raise the price level through accommodative monetary policy. According to the consumer price trends for December and the year announced by Statistics Korea on the 31st of last month, the consumer price index for this year was 105.42 (2015=100), a 0.5% increase compared to one year ago. This marks the second consecutive year with an annual consumer price inflation rate in the 0% range, following last year’s 0.4%, which is the first time since the related statistics began in 1965.

At a press conference held immediately after the last Monetary Policy Committee (MPC) meeting on November 26 last year, Governor Lee also said, "Looking at the macroeconomic conditions, it is uncertain how the recovery will unfold," and "It is not a situation to hastily change the accommodative monetary policy stance." He added, "As the impact of COVID-19 gradually weakens, we intend to maintain the accommodative monetary stance until the domestic economy continues on a stable recovery path."

In response to the COVID-19 crisis, the Bank of Korea held an emergency MPC meeting in March last year and lowered the base interest rate by 0.5 percentage points from 1.25% to 0.75%. In May last year, the base rate was further reduced to a historic low of 0.5%. Since then, at each of the four MPC meetings, the committee members unanimously decided to keep the base rate unchanged. This decision was based on the judgment that accommodative monetary policy should be maintained as the real economy was contracted due to COVID-19 and both companies and households had increased their borrowings.

However, the possibility of further cuts to the base interest rate this year appears low. The rate cuts last year led to overheating in asset markets such as real estate and stocks, and further rate reductions could exacerbate asset market imbalances. There is also widespread analysis that the base interest rate is approaching the effective lower bound (the lower limit of the rate level without concerns about capital outflows or liquidity traps). In such a situation, additional rate cuts could cause side effects such as foreign capital outflows. Unless the COVID-19 situation suddenly worsens drastically or the financial markets fluctuate as they did in early last year, it will be difficult to lower the base interest rate further.

In his New Year's address, Governor Lee stated, "Concerns about the risks of accumulating financial imbalances, such as liquidity released during the COVID-19 response flowing into asset markets and an increase in private credit, have also risen, so attention must be paid to the financial stability situation."