Base Interest Rate Frozen for 11 Consecutive Times... Lee Chang-yong Says "Uncertainty Over Rate Cut Timing Has Increased" (Comprehensive Report 2)

Bank of Korea Holds Base Rate Steady for 11th Consecutive Time Amid Economic Improvement and High Inflation
Economic Growth Forecast Raised from 2.1% to 2.5% for This Year
Many Expect Bank of Korea to Cut Rates in Q4 Following US Rate Cut in Q3

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee meeting held at the Bank of Korea headquarters in Jung-gu, Seoul, on the 23rd. Photo by Joint Press Corps

Lee Chang-yong, Governor of the Bank of Korea, stated at a press conference held immediately after the decision to keep the base interest rate unchanged on the 23rd, "The uncertainty regarding the timing of the current interest rate cut has increased significantly compared to last month."

At the meeting held at the Bank of Korea headquarters in Jung-gu, Seoul, on the morning of the same day, Governor Lee said, "There are expectations for an interest rate cut in the second half of this year, but upward pressure on inflation persists."

The Bank of Korea's Monetary Policy Committee (MPC) decided to keep the base interest rate at 3.50% per annum during the monetary policy direction meeting held that day. The MPC has maintained the base rate unchanged for 11 consecutive times since February last year.

Governor Lee said, "Compared to last month, the uncertainty about the timing of the interest rate cut has increased," adding, "If the downward trend in the consumer price inflation rate in the second half of the year is clearly confirmed, we can consider lowering the interest rate." He also mentioned, "We have maintained the annual inflation forecast at 2.6% for this year but revised the expected monthly average inflation rate for the second half from 2.3% to 2.4%."

The Bank of Korea significantly raised its economic growth forecast for South Korea this year from the previous 2.1% to 2.5%, while maintaining the inflation forecast at 2.6%. The growth forecast was sharply revised upward due to continued improvement in exports and a recovery in domestic demand. Governor Lee's remarks on the day were interpreted to mean that the upward pressure on inflation has increased as the Korean economy improved more than expected, thereby increasing the uncertainty about an interest rate cut.

Governor Lee explained, "Regarding the interest rate level three months from now, one of the six MPC members, excluding myself, expressed the opinion that the possibility of a rate cut should be kept open, as was the case previously." He added, "The other five members believed it would be desirable to maintain the rate at 3.5% three months from now."

He stated that there was no discussion among the MPC members about the magnitude of a future interest rate cut. Governor Lee said, "We need to confirm the timing of the rate cut and then consider the extent, but since the uncertainty about the timing has increased, we have not yet discussed that far." He added, "If inflation stabilizes, we will consider how to balance domestic demand and exports and how to maintain future financial stability if rates are lowered too much, and then decide on the magnitude."

Judgment That It Is Premature to Cut Base Interest Rate Amid Economic Improvement and High Inflation

The MPC's decision to keep the base interest rate unchanged is based on the judgment that the inflation situation remains unstable. The consumer price inflation rate was 3.1% year-on-year in February, 3.1% in March, and 2.9% in April, still significantly exceeding the Bank of Korea's inflation target of 2%. High inflation continues due to sharp rises in international oil prices as well as major agricultural products such as apples and pears.

Kang Sung-jin, Professor of Economics at Korea University, said, "Inflation is the most important factor in deciding the base interest rate, and inflation is still not stable," adding, "If we lower the interest rate and the interest rate gap between Korea and the U.S. widens, the exchange rate could rise, which may negatively affect inflation."

The fact that South Korea's economic growth rate is exceeding expectations this year also weakens the rationale for cutting the base interest rate. South Korea's economic growth rate in the first quarter was 1.3% quarter-on-quarter, significantly surpassing the market expectation of around 0.6%. The surprise growth was driven by continued export strength, improved construction performance, and private consumption. Accordingly, the Bank of Korea sharply raised its economic growth forecast for South Korea this year from 2.1% to 2.5% on the same day.

Governor Lee cited the increase in net exports as the main reason for raising the economic growth forecast from 2.1% to 2.5%. He said, "External factors such as the global IT industry boom and strong growth in the U.S. economy contributed to the upward revision of the growth forecast by 0.3 percentage points." He also mentioned, "Domestic factors such as sluggish domestic demand contributed to a 0.1 percentage point increase."

Earlier, the Organisation for Economic Co-operation and Development (OECD) and the Korea Development Institute (KDI) also revised their economic growth forecasts for South Korea this year from 2.2% to 2.6%. Moody's raised its forecast from 2.0% to 2.5%, and the Korea Financial Investment Association Research Institute raised it from 2.1% to 2.5%. Major global investment banks (IBs) such as Goldman Sachs, JP Morgan, HSBC, and Nomura also raised their growth forecasts for South Korea to around 2.5%. As the Korean economy is expected to perform better than previously predicted this year, there is an analysis that the Bank of Korea has no reason to rush to lower interest rates.

Ahn Jae-kyun, an economist at Shinhan Investment Corp., analyzed, "With the first quarter economic growth rate coming out higher than expected, the need for the Bank of Korea to quickly cut the base interest rate has decreased compared to the beginning of the year."

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the Monetary Policy Committee meeting held on the 23rd at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

Bank of Korea Expected to Cut Rates Only After U.S. Rate Cut

The delay in the expected timing of the U.S. base interest rate cut is also a factor delaying the Bank of Korea's rate cut. Until last month, the market expected the U.S. Federal Reserve (Fed) to cut the base interest rate in the second quarter of this year. However, due to persistent high inflation, the expected timing has been pushed back to the third quarter.

In March, the U.S. Personal Consumption Expenditures (PCE) rose 2.7% year-on-year, exceeding the market forecast of 2.6%. The slow pace of inflation easing has made the Fed cautious about cutting rates.

The minutes of the U.S. Federal Open Market Committee (FOMC) released the day before were somewhat hawkish. The minutes showed that members were disappointed with the first quarter inflation indicators and projected, "It will take longer than expected to gain confidence that inflation is moving toward the 2% target." Fed Governor Christopher Waller also said in an interview with local media on the 21st, "We need to see the slowdown in inflation indicators continue for about 3 to 5 months to consider a rate cut by the end of the year."

Regarding a question about the decoupling from U.S. monetary policy, Governor Lee replied, "We will conduct monetary policy in the second half of the year while observing the impact of changes in U.S. monetary policy on the exchange rate market, capital mobility, and the domestic market."

Many experts believe it would be burdensome for South Korea to cut the base interest rate before the U.S. in the current uncertain U.S. monetary policy environment. The market consensus is that the U.S. will cut rates first in the third quarter, and South Korea will follow with a rate cut around the fourth quarter.

Joo Won, Head of Economic Research at Hyundai Research Institute, said, "Since our monetary policy is heavily influenced by the U.S., it is unlikely that the Bank of Korea will cut the base interest rate ahead of the U.S. If the U.S. cuts rates as early as September, the Bank of Korea is expected to cut rates around October."

Park Chun-sung, Head of Macroeconomic Research at the Korea Institute of Finance, also said, "The biggest variable in our monetary policy currently is the U.S. base interest rate cut. I expect the U.S. to cut rates first in the third quarter, and South Korea will cut rates after confirming that."