Bank of Korea: "Low Possibility of House Prices Dropping in Short Term... Caution Needed" [Q&A]

September Monetary and Credit Policy Report Press Briefing

The Bank of Korea recently stated that the upward trend in housing prices is unlikely to reverse in the short term and that vigilance must be maintained. The trajectory of household debt is expected to be a key variable in future base interest rate decisions.

[Image source=Yonhap News]

Park Jong-woo, Deputy Governor of the Bank of Korea, said at a press briefing following the release of the 'Monetary and Credit Policy Report' on the 12th, "If the Bank of Korea lowers interest rates within the year, it will be in a situation where various government policies related to household debt are clearly effective."

Regarding the outlook for the real estate market and household debt, he said, "There were various factors that caused a significant increase in August, but in September, it seems the pace will slow down compared to August," adding, "Housing prices are still rising, but the rate of increase is slowing down, and transaction volumes are also gradually declining." However, he explained, "The possibility of housing prices dropping within a month or two is low," and "Although the rate of increase is clearly slowing, the level remains high, so continuous vigilance is necessary."

In response to opinions that interest rates should have been lowered in August, he said, "I agree that conditions for normalizing interest rates have been established in terms of inflation," but added, "Interest rate adjustments fundamentally affect the economy indiscriminately, so when effects occur on one side, side effects inevitably accompany the other. When deciding monetary policy, these factors must be comprehensively considered."

Regarding current market interest rates, he said, "Expectations for rate cuts have been largely priced in, reflecting more than two cuts this year," and warned, "If market expectations get ahead, volatility may increase during the adjustment process, so it is important to manage so that policy intentions and market expectations do not diverge significantly."

Below is a Q&A with Deputy Governor Park Jong-woo.

- Is the current 3.5% base interest rate in the tightening zone? Why is the financial environment becoming quite accommodative despite the rate freeze?

▲It is true that overall financial conditions are becoming quite accommodative. This is basically because expectations for future rate cuts have been largely priced in. Similar situations appeared before previous base rate cut cycles, but this time the impact seems greater than before. For example, current market interest rates roughly reflect expectations of more than two cuts this year, which is somewhat excessive considering future policy conditions and past cases. If market expectations get ahead, volatility may increase during the adjustment process, so it is important to manage so that policy intentions and market expectations do not diverge significantly.

- You mentioned that the base interest rate is approaching a neutral level. Does this mean it is close to a rate cut?

▲I did not specify when the rate cut will occur. Two points should be kept in mind. First, Korea raised rates preemptively compared to major countries, which allowed inflation to stabilize somewhat with relatively fewer hikes. Comparing current policy rates of major countries, Korea’s base rate remains significantly lower. Therefore, these factors should be considered when forming expectations about the magnitude and speed of future rate cuts.

▲Second, in conducting monetary policy, we consider the overall macroeconomic trend. We will continue to carefully monitor financial stability and make decisions accordingly.

- Since July, you have emphasized the need to communicate to prevent excessive expectations of rate cuts. However, market rates have not fallen. You analyzed that external factors have a large influence, but some Monetary Policy Board members seem to have mixed communications, with more members opening the possibility of rate cuts within three months. The survey in the report expects a 2.75% rate by the end of next year. Do you think expectations for the future base rate path are excessive?

▲It seems premature to comment on the situation after next year. Even this year, the level reflects more than two rate cuts. However, expert surveys in the market do not expect that level. In that sense, I say expectations are excessive. When forming expectations about the speed of future rate cuts, it would be good to consider the points I mentioned earlier.

- You have repeatedly mentioned a policy mix. Does the government strengthening regulations itself create conditions for rate cuts? Or do you need to confirm that household debt is being controlled through policies before rate cuts are possible?

▲Before last month’s rate decision, the government announced various supply and demand management measures. Since these policies were introduced last month, we will observe their effects and comprehensively judge whether the effects will continue before deciding on rates.

▲I am aware of opinions that rates should have been cut in August. Nevertheless, caution is necessary because, in terms of inflation, conditions for normalizing rates have been established. Also, the recovery in purchases is still slow, so this must be clearly considered when deciding monetary policy. At the last Monetary Policy Board meeting, four members opened the possibility of a cut within three months considering these factors. Rate adjustments fundamentally affect the economy indiscriminately. When effects occur on one side, side effects inevitably accompany the other. I believe monetary policy decisions must comprehensively consider these factors.

▲Domestic demand in August was not satisfactory but showed slight improvement. Looking at the first and second weeks of August, housing price growth and transaction volumes peaked. Internal data estimated that household debt growth in August would be quite large, at least 8 trillion KRW, possibly over 9 trillion KRW. Cutting rates in such a situation could fuel overheating sentiment in the housing market, so this was taken into account.

▲When comparing the effect of rate cuts on stimulating domestic demand and the increased financial stability risks, it was judged better to observe the policy effects and household loan stabilization before cutting rates, so the rate was held steady in August.

- You mentioned significant uncertainty regarding the real estate market and household debt. You expected large household debt in August. How do you see the direction of the real estate market and household debt in September and October?

▲August saw a significant increase due to various factors. It is difficult to say how much it will be in September, but it seems to slow down compared to August. Weekly data on housing market transaction volumes and price growth show that housing prices are still rising but at a slowing pace, and transaction volumes are gradually declining. We are monitoring whether this trend will continue.

- Recently, Monetary Policy Board member Shin Sung-hwan made remarks suggesting rate hikes. Are you considering rate hikes now?

▲We have not started rate cuts yet. Talking about rate hikes again seems premature. One thing I want to say is that when discussing financial imbalances, we usually refer to asset price increases disconnected from fundamentals or excessive credit expansion. In conducting monetary policy, we focus not only on housing price increases themselves but also on the resulting household debt growth.

▲Some think including metropolitan area housing prices in the Monetary Policy Board’s resolution targets specific regional asset prices. However, this inclusion is because provincial areas continue to decline. Metropolitan housing prices are high and account for a large share of total housing market capitalization and household loans, thus influencing the overall situation.

- You said the pace of private consumption recovery will accelerate. Is this forecast based on assuming rate cuts within the year, or do you expect private consumption to recover faster even without rate cuts?

▲(Lee Ji-eun, Head of Economic Trend Team) When forecasting private consumption, we do not set policy rates but consider market participants’ expectations. Private consumption was unsatisfactory until July but is expected to rise as wage growth improves in the second to fourth quarters.

- The housing market risk index was 1.11 in July, with overheating risk starting at 1.5. Does the August figure approach the overheating zone?

▲The August figure is estimated to have risen slightly from this. Whether it reaches the overheating risk stage can be seen by looking at 2020 and 2021. If the current situation continues for one to one and a half years, overheating risk will increase. If such a period persists, overheating risk could be reached.

- Regarding the housing market outlook, even the view that it will gradually stabilize says the stabilization point is after next year. If stabilization is after next year, could the pace of rate cuts slow?

▲There is great uncertainty about the housing market outlook, so both views were described. It is difficult to assert the situation after next year. However, housing prices have surged sharply in a short period, reaching a burdensome level. Various government policies are being implemented cautiously, and although the price-to-income ratio and jeonse (long-term lease) ratio are not as high as in the past, speculative demand may persist. Therefore, I cautiously believe the trend of rising housing prices will not continue long-term. Household debt increased significantly in August and shows signs of slowing in September, but whether this trend continues is uncertain, so vigilance is maintained.

▲Currently, we must carefully monitor financial stability and cautiously adjust the pace. Decisions are not based on just one or two months of data but on overall trends.

- You said that in deciding the timing and speed of future rate cuts, you consider both growth trends and financial stability risks, which can conflict. The Monetary Policy Board minutes emphasize policy coordination. Does this mean that even if rates are cut to stimulate domestic demand, macroprudential regulations could be strengthened to control household debt or housing prices?

▲From the central bank’s perspective preparing for a monetary policy pivot, government macroprudential policies that can mitigate side effects are very appropriate measures. We will observe how these actually work and decide accordingly.

▲Both we and financial authorities agree on the need to pay attention to the housing market and household debt. Regarding additional measures, as financial authorities recently stated, if the housing market or household debt trends require it, bold additional measures will be promptly implemented. We also convey such opinions.

- In analyzing private consumption trends, you noted that the business conditions of self-employed persons may not recover. Since private consumption recovers, why do you see this differently?

▲Private consumption is expected to gradually recover, as seen in July and August. However, the business conditions of self-employed persons have improved slowly and polarization issues are severe. While private consumption overall will recover, difficulties among vulnerable groups will persist, so the pace of improvement may be slower.

- The August Monetary Policy Board minutes state that related ministries said the recent rise in metropolitan housing prices is unlikely to subside in the short term. How long is the short term?

▲The minutes reflect the situation during the August Monetary Policy Committee meeting. At that time, housing market overheating sentiment was at its peak, and household debt growth in August was expected to be large, so this was addressed during the meeting. The trend is expected to decline in September, but the housing market has a large momentum, so it is difficult to expect a drop in the short term. The rate of increase is slowing. At that time, it was difficult to expect stabilization within a month or two. Now, government measures are easing sentiment, and we hope this continues.

- Do you think the real estate market has improved since the August Monetary Policy Board meeting?

▲Saying the situation has improved is not accurate. Saying it has improved implies reassurance, which is not the case. Housing price growth rates and transaction volumes are slowing slightly but remain high compared to past averages, so vigilance is necessary.

- Due to holidays, it is difficult to accurately assess household debt size in September and October. Does this mean the possibility of a rate cut in October is low?

▲I cannot comment on the October rate decision here. We will decide based on data through September and the trend of financial stability risks.

- It seems you still keep the door open for rate cuts within the year. How do you view the risk of rate cuts overheating the housing market?

▲If rate cuts occur within the year, they will be made when various government measures are clearly effective. Macroprudential policies and interest rate policies should align to alleviate financial imbalances. However, members who keep the possibility of rate cuts open generally believe that, given inflation conditions, the current base rate level is tight and should be adjusted to a neutral level when conditions permit. Domestic demand is expected to rise but the recovery level is not satisfactory compared to the past, and structural factors create uncertainty about the pace of recovery. These factors will be considered in rate decisions.

- Do you think the financial authorities’ July postponement of the second phase stress DSR (Debt Service Ratio) measure was appropriate?

▲I understand that financial authorities considered various factors at that time. We agree with the signal sent to the market and know that financial authorities have discussed related issues. There was some confusion regarding loan interest rate adjustments, but recent days have seen some adjustments, and we acknowledge that.

- You forecast household debt to stabilize after next year. If slowdown is confirmed through various indicators, could rate cuts occur within the year?

▲I said after next year because the possibility of housing prices dropping within a month or two is low. Although the rate of increase is slowing, the level remains high, so vigilance is necessary.

- The correlation coefficient between household debt and private consumption is negative, meaning that as household debt increases, consumption decreases. What effects do you expect if rates are cut now?

▲Rate adjustments naturally affect consumption. Adjusting rates impacts not only loans but also interest burdens, employment, and wages, so income effects from rate adjustments are internally estimated. However, since household debt levels are high and principal repayments continue, these effects may be weaker than in the past.

▲As inflation conditions mature, the need to bring rates to a neutral level and the unsatisfactory pace of domestic demand recovery compared to past recoveries are factors that could justify considering rate cuts. However, financial stability must be carefully monitored throughout. Market participants should consider these factors when forming rate expectations.