Bank of Korea Holds Interest Rate Steady for 12th Consecutive Time, Longest Period Amid Exchange Rate and Household Debt Concerns (Comprehensive)

Stable Inflation but Many Uncertainties Like Exchange Rates and Housing Prices
If the US Lowers Interest Rates in September, the Bank of Korea May Follow in October
Possibility Raised for Earlier Rate Cut in August to Boost Domestic Demand Compared to the US

The Bank of Korea has kept the base interest rate steady at 3.50% for the 12th consecutive time. Although inflation is showing signs of stabilization, the rate was held due to renewed concerns over household debt and instability in the foreign exchange market. There was also pressure regarding the burden of lowering the base rate ahead of the United States. However, the market expects the Bank of Korea to cut the base rate as early as next month or by October at the latest to boost the sluggish domestic economy.

The Monetary Policy Board (MPB) of the Bank of Korea held the base interest rate at 3.50% during its monetary policy meeting on the morning of the 11th at the Bank’s headquarters in Jung-gu, Seoul. The MPB has maintained the base rate at the current level for 12 consecutive times since February last year.

The 3.50% base rate has been in place for about 1 year, 6 months, and 28 days since January 13 of last year, marking the longest freeze period in history. The previous longest freeze period was 1 year, 5 months, and 21 days from June 9, 2016, to November 30, 2017.

Inflation Stabilizing but Many Risks from Exchange Rate and Household Debt

The Bank of Korea’s decision to hold the base rate is due to renewed pressures on the economy from rising household debt and a high exchange rate.

Recently, as apartment prices have risen mainly in Seoul, mortgage loans have surged, bringing the household debt issue back to the forefront.

According to Bank of Korea statistics, the increase in mortgage loans in the banking sector in June was 6.3 trillion won, the largest in 10 months since August last year. The cumulative increase in mortgage loans in the first half of this year reached 26.5 trillion won, the largest in three years since the first half of 2021. As market expectations for a rate cut grew, signs of rising housing prices reappeared, leading more people to buy homes even by borrowing.

Governor Lee Chang-yong also expressed concern at the National Assembly on the 9th, stating, "Housing prices have risen recently, especially in the metropolitan area, and the increase in household debt has expanded compared to earlier this year." In such a situation, lowering the base rate could trigger a recurrence of financial instability such as the housing price surge and rapid increase in household loans seen several years ago.

Instability in the foreign exchange market continues as well. With the expected timing of the U.S. rate cut pushed back, the won-dollar exchange rate hit 1,400 won intraday in April and remains around 1,380 won. It is highly unusual for the won-dollar exchange rate to stay in the high 1,300 won range for such a prolonged period despite the absence of an economic crisis.

In this context, lowering the base rate could push the exchange rate higher and potentially drive inflation, which has recently stabilized, back up.

According to Statistics Korea, the Consumer Price Index (CPI) rose 2.4% year-on-year last month, the lowest increase in 11 months since July last year. Although it has not yet reached the Bank of Korea’s target level of 2%, it is close to the "2.3?2.4% trend in the second half" that Governor Lee mentioned as a prerequisite for considering a rate cut.

Heo Moon-jong, head of the Economic and Financial Market Research Division at Woori Financial Research Institute, said, "Due to concerns about the won’s depreciation, it is burdensome for the Bank of Korea to lower rates now," adding, "The rebound in the real estate market amid rising household debt is also a risk factor."

Lee Chang-yong, Governor of the Bank of Korea, is presiding over a meeting at the Financial Monetary Policy Committee held at the Bank of Korea headquarters in Jung-gu, Seoul, on the 11th. Photo by Joint Press Corps

Many Opinions Say U.S. Must Cut Rates First Before We Do

The fact that the U.S. Federal Reserve (Fed) has not yet cut its base rate is also a burden for the Bank of Korea to lower rates ahead of the U.S.

Kang In-soo, professor of economics at Sookmyung Women’s University, said, "There is a significant burden in cutting rates ahead of the U.S. now," explaining, "If the interest rate gap widens, there is a risk of capital outflow."

The market increasingly expects the U.S. to cut its base rate around September. Fed Chair Jerome Powell appeared before the U.S. House Financial Services Committee on the 10th (local time) and stated that monetary policy could be eased before inflation reaches the Fed’s 2% target, depending on the situation. He said that a rate cut does not have to wait until inflation fully reaches 2%, adding, "Inflation will move downward and probably fall below 2%, which is not the situation we want."

The prevailing view in the market is that if the Fed cuts the base rate in September, South Korea will follow with a rate cut in October.

In a survey conducted last week by Asia Economy among 20 economic experts, 11 predicted that the Bank of Korea would cut the base rate in October. Experts identified the timing of the U.S. rate cut as the biggest variable for domestic monetary policy going forward.

Jo Young-moo, research fellow at LG Economic Research Institute, said, "The biggest variable in the Bank of Korea’s base rate decision is the timing of the U.S. rate cut," adding, "Considering the current unstable exchange rate and the interest rate gap with the U.S., it is difficult for us to cut the base rate before the U.S."

Jung Sung-tae, research fellow at Samsung Securities, also said, "Considering the current unstable foreign exchange market, we expect the U.S. to cut the base rate around September and us to lower rates around October."

However, some opinions suggest that the Bank of Korea might cut rates ahead of the U.S. next month, considering stabilizing inflation and sluggish domestic demand.

Moon Hong-chul, research fellow at DB Financial Investment, said, "The domestic economy is very sluggish, mainly driven by domestic demand, and exports are unstable as semiconductors are the only sector performing well," adding, "The Bank of Korea may cut the base rate in August to stimulate the economy."

Kim Young-ik, professor at Sogang University Graduate School of Economics, said, "There are concerns that foreign capital might flow out if we cut rates before the U.S., but foreign net purchases of domestic stocks have reached 23 trillion won this year, so the risk of capital outflow is not significant," concluding, "Cutting rates before the U.S. should not be a major problem."