[Insight & Opinion] Conditions for a Rate Cut

Stabilizing the Unstable Real Estate Market Comes First
Household Debt Burden Prevents Growth in Consumption

The Presidential Office expressed regret over the Bank of Korea's decision to keep the base interest rate unchanged. This is an unusual reaction, indicating that expectations were quite high.

The pressure to lower the base interest rate was intense. The Chief of the Presidential Secretariat for Policy called for a flexible monetary policy, and the Prime Minister openly demanded a rate cut, stating that the base rate could only go down. The ruling party also advocated for a rate cut. The Korea Development Institute (KDI) lowered its growth forecast for this year to 2.5%, attributing the economic slowdown to weak domestic demand, which in turn was mainly caused by prolonged high interest rates, thus leading the call for a rate cut.

However, the Monetary Policy Committee ultimately kept the base interest rate steady at 3.5% this month as well. Even though it lowered this year’s growth forecast to 2.4%, which is below KDI’s estimate, it did not adjust the interest rate.

There is no dispute about the weak domestic demand. The contribution of domestic demand to growth fell from 4.1% in 2021 to 2.7% in 2022, and further down to 1.4% in 2023, with a negative growth rate in the first half of this year in the 1% range. Private consumption is particularly poor. The private consumption growth rate, which was 4.3% in 2022, dropped to 1.7% last year and plummeted to 0.9% in the first half of this year. Retail sales have shrunk at the largest rate in 15 years. Clearly, the domestic demand slump is severe.

However, the surge in household debt and the unstable real estate market are hindering interest rate cuts. The government itself made the situation difficult. Early last year, financial authorities forcibly lowered mortgage loan interest rates to revive the sluggish real estate market. The Financial Supervisory Service chief pressured commercial banks one by one to reduce rates. The inevitable result was an increase in household loans and instability in the real estate market.

The current government’s household debt policy is confusing. On one hand, it induces interest rate hikes to curb household debt growth, while on the other hand, it floods the market with low-interest policy mortgage loan programs and delays tightening loan regulations. At times, it expanded the scope of policy products, but now it is raising the interest rates on policy loans while reducing policy lending. The current phenomenon of market interest rates falling while loan interest rates rise is a result of government actions.

Consistency in policy is necessary because any policy that fails to gain the trust of economic agents is unlikely to be effective. If it is difficult to predict when loan regulations will change or loan limits will be adjusted, it may be better to take out a loan and buy a house immediately. Household debt has increased by 10 trillion won over the past two months, setting a new record high. Lowering the base interest rate in the current situation is likely to increase market instability. Already, actual apartment sale prices in Seoul and the metropolitan area have risen for seven consecutive months from January to July 2024, and Seoul apartment prices have increased for 21 consecutive weeks up to the second week of this month.

A September rate cut by the U.S. Federal Reserve is now certain. Since the tightening began in early 2022, the direction of monetary policy is changing for the first time in three and a half years. Many central banks around the world have already cut rates this year. If the U.S. lowers its base rate, the Bank of Korea will have greater room to attempt a policy shift. Missing the right timing in monetary policy can cause significant side effects.

It is now time to change the policy direction. But nothing in this world is free. To minimize the side effects of a rate cut, the real estate market must first be stabilized. The upward trend in household debt must be controlled. If a rate cut only leads to increased household debt, consumption spending will not rise due to debt burdens, making it difficult to stimulate domestic demand. A rate cut in August was impossible from the start. In fact, the real challenge begins now. So, can the conditions be met after September? If not, what should be done? Should the rate still be lowered?

Kim Sang-cheol, Economic Commentator