[Insight & Opinion] Leave Housing Prices to the Government, the Bank of Korea Should Cut Rates

Apartment Market Overheating Driven by Structural Factors
Long-Term Domestic Demand Slump Deepens Economic Challenges
Need to Ease Interest Rate Burden on Businesses and Households

Lee Chang-yong, Governor of the Bank of Korea, mentioned "real estate" more than 40 times during the monetary policy direction press conference on August 22 while explaining the Monetary Policy Committee's decision to hold interest rates steady for the 13th consecutive time, attributing the inability to lower rates despite the economic conditions calling for a rate cut to the housing market.

If the Monetary Policy Committee sets the stabilization of the apartment market as a prerequisite for lowering interest rates, this effectively signals to the public not to expect rate cuts for a considerable period. This is because the current overheating in the apartment market is driven by structural causes, making a short-term cooling unlikely.

The volume of apartment transactions in Seoul in July was 8,597, a 129% increase compared to 3,747 in July last year. According to the Korea Real Estate Board, Seoul apartment prices have risen for 22 consecutive weeks until recently. Moreover, the heat in the Seoul apartment market is spreading to the greater metropolitan area. The reasons for the overheating include a 50% increase in construction costs over the past two years, a 25% decrease in this year’s housing supply compared to last year, and especially the expectation that the supply in 2026 will drop to about one-quarter of that in 2025. Due to the inevitable sharp rise in new apartment prices and the absolute shortage of supply, price increases in newly built apartments are as certain as seeing fire, which explains the surge in transactions and price hikes. Given this long-term supply-demand imbalance, early stabilization is hard to expect. The clear fact is that the housing price issue has already surpassed the dimension of interest rates.

Meanwhile, despite exports showing an 11-month consecutive increase compared to the same months last year up to August, domestic demand continues to stagnate, and the wounds from high interest rates are evident in many areas. The delinquency rate on won-denominated loans at domestic banks rose from 0.2% in June 2022 to 0.35% in June 2023 and further to 0.51% in May 2024. According to Korea Credit Data, as of the end of Q1 2024, the delinquency ratio of loans to individual business owners reached 1.8%. Additionally, the Bank of Korea’s corporate management analysis shows that among externally audited companies, 40% last year were marginal firms with an interest coverage ratio below 100%, meaning they could not cover interest expenses with operating profits. The pain households and companies endure due to economic recession and high interest rates is severe.

While it is clear that lowering interest rates stimulates capital inflow into the real estate market and boosts loan demand, under current circumstances, the positive effect of easing the high-interest burden on businesses and households outweighs these side effects. Especially from September, banks plan to implement the second phase of the stress test on the Debt Service Ratio (DSR). If loan demand pressure does not ease, banks may reduce lending on their own, or financial authorities may impose quantitative regulations. This situation calls for government-directed finance.

What the Monetary Policy Committee must pay attention to above all is that the current economic situation is not a normal one that justifies hesitating to cut rates due to housing price issues. Despite export growth, the Korean economy is experiencing a long-term domestic demand slump due to structural polarization pains. The government has already set next year’s budget increase rate at around 3%, making it clear that fiscal policy will have limited capacity to stimulate domestic demand next year. If the government lacks the budget to boost domestic demand and the Bank of Korea refuses to cut rates because of the apartment market, what else does this mean but asking the public to fend for themselves? Therefore, the Bank of Korea should leave the housing price issue to the government and ease the burden on households and businesses through interest rate cuts.

Kim Dong-won, Former Visiting Professor at Korea University