[High Inflation War]③ "Prices Stabilized, Now Household Debt"... Will There Be an Interest Rate Cut in October?

Inflation Rate Target Reached 2%
Interest Rate Cut Possible Only After Household Debt Control Success
Calls for Urgent Rate Cut to Boost Domestic Demand Emerge

Consumer prices have reached 2%, signaling the end of the high inflation era, but 'household debt' has rapidly emerged as a key variable in deciding the base interest rate. Many expect the Bank of Korea to cut the base rate next month to stimulate domestic demand, assuming that government loan regulations will ease the rise in household debt.

[Image source=Yonhap News]

The consumer price inflation rate announced on the 3rd for August recorded 2.0%, reaching the Bank of Korea's price stability target. With the Bank of Korea's top priority of 'price stability' effectively achieved, conditions for a rate cut have been created if only inflation is considered.

While prices have stabilized, the problem lies in 'financial stability.' In addition to its primary goal of price stability, the Bank of Korea also prioritizes financial stability as a secondary objective. Recently, the rising trend of household debt, especially in the Seoul metropolitan area, has not subsided, acting as a factor hindering interest rate cuts. Last month, the Bank of Korea's Monetary Policy Committee (MPC) decided to keep the base rate unchanged, citing financial stability as the reason. The MPC stated in its monetary policy direction resolution, “Although inflation has stabilized recently, the rise in housing prices in the metropolitan area and the consequent increase in household debt could threaten financial stability, so the rate was held steady.”

Even after the August MPC meeting, the increase in household debt continues. As of the end of last month, the outstanding balance of mortgage loans at the five major commercial banks was 568.6616 trillion won, an increase of 8.9115 trillion won in just one month. This is the largest increase since statistics began in 2016. Consequently, Shin Sung-hwan, a member of the MPC known as a representative dove (favoring easing), made hawkish (favoring tightening) remarks.

After the Jackson Hole meeting last month, Shin said, “In extreme situations where housing prices rise, interest rates may need to be raised.” On the 3rd, he added, “Housing prices have already entered bubble territory,” and stated, “We need to observe how effective various financial authority measures are in the actual market and make judgments, but if all policies prove ineffective, there may be no other choice,” even mentioning the possibility of a rate hike.

Although the risk of household debt triggering a financial system crisis is low, excessive debt burdens are delaying the recovery of private consumption and restricting the implementation of economic policies such as monetary policy. According to last month's report by Korea Ratings titled ‘Is Household Debt Manageable?,’ risk management in the financial sector is being conducted relatively strictly under the government's household debt management policy.

However, due to high interest rates and prolonged economic downturn, the delinquency rate on household loans has been rising since 2022 and has exceeded pre-pandemic levels this year. The household credit-to-GDP ratio, which exceeded 100% since the third quarter of 2020, has fallen to the 90% range but still significantly surpasses the critical level (75?85%) that hinders economic growth.

Will there be a rate cut in October? “Household debt vs. domestic demand are key variables”

Financial authorities have introduced stringent loan regulations this month. To curb the rise in household debt, they have strengthened the second stage of the Debt Service Ratio (DSR) stress test from this month, applied higher additional interest rates on mortgage loans in the metropolitan area, and tightened loan limits. The financial authorities are reportedly considering extending credit loan regulations to the secondary financial sector to prevent a balloon effect expanding from mortgage loans to credit loans.

Woori Bank has raised both the upper and lower limits of its 5-year fixed-rate mortgage loan interest rates by 0.11%, while Shinhan Bank plans to increase its mortgage loan interest rates by 0.05% starting from the 15th. The photo shows a promotional notice for the Housing and Urban Fund trustee bank posted at the entrance of a Shinhan Bank branch in Seoul. Photo by Kang Jin-hyung aymsdream@

If the financial authorities' loan regulation policies prove effective this month, the likelihood of the Bank of Korea cutting rates in October is expected to increase. Jeong Kyu-chul, head of the Economic Outlook Division at the Korea Development Institute (KDI), said, “If government policies successfully curb the rise in household debt, it will be easier for the Bank of Korea to decide on a rate cut in October.”

Separately from the rise in household debt, calls for an urgent rate cut to stimulate domestic demand are growing. Joo Won, head of the Economic Research Division at Hyundai Research Institute, said, “The U.S. is expected to cut rates this month, and the current atmosphere is that domestic demand is quite weak, so the Bank of Korea has no choice but to cut rates in October,” adding, “If the rate cut is delayed further, the Bank of Korea could face criticism for domestic demand weakness.”

However, some argue that it will take considerable time to confirm the effects of the financial authorities' loan regulations, making an immediate rate cut in October unlikely. Jo Young-moo, a research fellow at LG Economic Research Institute, said, “If the rise in household debt or housing prices is not confirmed through data, it will be difficult to cut rates in October.”