Bank of Korea's Monetary Policy Committee Lowers Base Rate from 3.50% to 3.25%
Impact of US Rate Cut, Price Stability, and Domestic Demand Slump
The Monetary Policy Committee of the Bank of Korea held a meeting on the morning of the 11th and decided to cut the base interest rate. (Photo by Bank of Korea)
The Bank of Korea (BOK) has abruptly cut the base interest rate by 0.25 percentage points. This marks the beginning of a pivot (monetary policy shift) as the monetary tightening stance that started in August 2021 turns to easing after 3 years and 2 months.
The decision to lower the rate is attributed to major countries such as the United States and Europe starting to cut rates, along with a clear stabilization of domestic inflation. The sluggish domestic economy is also cited as a reason why the BOK can no longer maintain its historically long high-interest rate stance. However, excessive household debt remains a concern.
BOK Abruptly Cuts Base Interest Rate by 0.25 Percentage Points
The Monetary Policy Board (MPB) of the Bank of Korea announced on the morning of the 11th at the BOK headquarters in Jung-gu, Seoul, that it has set the base interest rate at 3.25% per annum. This is a 0.25 percentage point reduction from the previous 3.50%.
The last time the BOK cut the base rate was 4 years and 5 months ago, in May 2020. At that time, the BOK lowered the rate to 0.50% to prevent an economic recession caused by the COVID-19 pandemic.
After concerns about high inflation arose due to the low interest rate stance, the BOK began a full-scale monetary tightening by raising the rate by 0.25 percentage points in August 2021. The BOK raised the base rate to 3.50% by January last year and maintained a record-long 13 consecutive rate holds until August this year. With this rate cut, the pivot from tightening to easing in monetary policy has started after 3 years and 2 months.
The end of the prolonged high-interest rate stance by the BOK is evaluated to be due to the removal of various obstacles that had previously constrained rate cuts, such as the U.S. lowering its base rate, price stabilization, and sluggish domestic demand. In particular, after the U.S. Federal Reserve (Fed) made a big cut of 0.5 percentage points last month, conditions for the BOK to cut rates have been substantially met.
The clear stabilization of inflation is also a factor leading to the rate cut. According to Statistics Korea, the consumer price index (CPI) inflation rate in September was 1.6% year-on-year, falling into the 1% range for the first time in 3 years and 6 months since March 2021 (1.9%). This is well below the BOK’s inflation target of 2.0%.
Slowing Household Debt Growth and Domestic Demand Slump Also Behind Rate Cut
There is also an assessment that the BOK cut rates because household debt growth has slowed recently and it judged that it could no longer overlook the sluggish domestic demand. According to the financial sector, the outstanding household loans at the five major domestic banks reached 730.9671 trillion won last month, increasing by 5.6029 trillion won from the previous month. After recording the largest monthly increase ever of 9.6259 trillion won in August, the growth slowed in September.
Domestic demand weakness is also a background factor for the rate cut. South Korea’s real gross domestic product (GDP) contracted by 0.2% quarter-on-quarter in the second quarter. This is the first quarterly contraction in 1 year and 6 months since the fourth quarter of 2022 (-0.5%). In particular, private consumption decreased by 0.2%, and facility investment and construction investment shrank by 1.2% and 1.7%, respectively.
However, the market expects that further rate cuts by the BOK within this year will be difficult due to ongoing household debt issues. South Korea’s household debt-to-GDP ratio stood at 91.1% as of the second quarter this year, still the highest level globally. The BOK points out that the household debt ratio needs to be lowered to around 80% to reduce the burden on the economy.
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