Korean Monetary Policy Following the EU? ... Preconditions for Proactive Interest Rate Cuts (Comprehensive) [Why&Next]

EU May Cut Interest Rates Proactively Ahead of US
South Korea Ranks 2nd in Inflation Control Among Top 10 Countries
To Lower Rates... Confidence in Inflation and Exchange Rate Stability Needed

[Image source=Yonhap News]

As monetary policies around the world show signs of decoupling, there is a possibility that South Korea's monetary policy will follow a trend similar to that of Europe. While the United States is experiencing a "lone boom" contrary to the global economic trend, South Korea and major European countries continue to face sluggish domestic demand. Voices are emerging that for South Korea to proactively cut interest rates, there must be confidence that inflation will decrease and that the exchange rate will remain stable.

On the 21st, major foreign media including the British weekly magazine The Economist evaluated that Asian countries such as South Korea and European Union (EU) countries like Italy have performed quite well in terms of inflation. In contrast, English-speaking countries such as Australia are experiencing delays in curbing inflation. According to a survey conducted by The Economist last month on 10 advanced countries regarding the degree of inflation persistence, South Korea ranked 9th among the top 10 countries, predicting it to be the second country among them to escape inflation. Australia and the UK ranked 1st and 2nd respectively, while the US ranked 5th. The lower the rank, the higher the likelihood of escaping inflation sooner.

On the 12th, Lee Chang-yong, Governor of the Bank of Korea, said at a press conference held after the Monetary Policy Committee meeting, "Monetary policy decoupling is progressing worldwide," and added, "Since the US has already given a pivot signal, (South Korea) may cut interest rates either before or after the US."

[Image source=Yonhap News]

Until now, countries have aligned their monetary policies with the US to avoid capital outflows caused by widening interest rate differentials with the US. However, this year, countries other than the US have shown sluggish economic trends or sufficiently eased inflation, leading them to make proactive pivots ahead of the US.

The European Central Bank (ECB) is also expected to pivot before the US Federal Reserve (Fed). Despite ongoing uncertainties such as inflation expansion due to Middle East conflicts, it is anticipated that interest rate cuts will proceed as long as there is no major economic shock. Christine Lagarde, President of the ECB, said in an interview with CNBC on the 16th (local time), "If there is no major shock to the economy, we will soon ease monetary tightening." This essentially indicates that the ECB will start cutting benchmark interest rates around June or July this year.

On the other hand, the US pivot is expected to be later than June. On the 16th, Jerome Powell, Chair of the Fed, said at a forum on the Canadian economy held in Washington D.C., "Recent data have not given clear confidence that inflation is reaching the 2% target," and "It suggests that it will take longer than expected to gain such confidence." Due to Powell's hawkish (monetary tightening preference) remarks, the market views a June rate cut in the US as unlikely.

[Image source=AP Yonhap News]

Will the Bank of Korea Make a Proactive ‘Pivot’?

The common factor among countries that have pivoted proactively ahead of the US is that indicators confirm that inflation has sufficiently stabilized. The Swiss National Bank, which cut its interest rate by 0.25 percentage points to 1.5% annually on the 21st of last month, stated in a press release, "The consumer price inflation rate is expected not to exceed 1.5% until 2026." The Czech Republic and Hungary also cut rates by 0.5 and 2.5 percentage points respectively this year, with both countries showing indicators confirming that inflation has entered a stable zone. Ultimately, it is analyzed that a proactive move is possible only when there is confidence that inflation will stabilize.

In addition, if there is confidence that the Korean won will not depreciate due to interest rate differentials with the US, South Korea can cut rates before the US. Yoon Yeo-sam, a researcher at Meritz Securities, said, "Assuming Europe cuts interest rates around June, South Korea must first check whether the euro does not show significant weakness before considering a rate cut," adding, "If it is confirmed that the euro does not weaken significantly, a rate cut could be possible around August, a tempo faster than the US’s possible rate cut timing in September."

Economic conditions are also a variable. On the 16th, the International Monetary Fund (IMF) downgraded the economic growth forecasts for European countries such as Germany (0.2%) and France (0.7%) in its 'April World Economic Outlook,' citing deteriorated consumer sentiment. These figures are 0.3 percentage points lower than the forecasts made in January this year. In contrast, the US is expected to show high growth of 2.7%, exceeding the previous forecast of 2.1%. Economic stimulus is more urgent in European countries than in the US.

Experts suggest that South Korea is likely to follow a monetary policy stance similar to Europe. Researcher Yoon said, "Although the recent high exchange rate increases uncertainty," he evaluated, "If the euro’s weakness remains limited even after Europe cuts interest rates, the possibility of South Korea cutting rates in the third quarter remains valid." Jeong Kyu-chul, head of the Economic Outlook Office at the Korea Development Institute (KDI), said, "The US economy is quite strong and requires high interest rates," adding, "On the other hand, South Korea’s domestic demand is sluggish and inflation remains high, so if inflation stabilizes further, South Korea can pivot regardless of the US."

However, some argue that proactive rate cuts are difficult because the economic situations of Europe and South Korea differ. Jo Young-moo, a research fellow at LG Economic Research Institute, said, "Europe’s economic growth rate was about 0.5% last year and is expected to be less than 1% this year, making it difficult to overlook a recession," adding, "Meanwhile, South Korea’s policy authorities expect economic growth in the low 2% range this year, so they will not rush to cut rates." In fact, unlike the IMF’s downgrade of European economic forecasts in its April World Economic Outlook on the 16th, South Korea’s economic growth forecast remained at 2.3%, the same as in January.