Bank of Korea Governor Lee Chang-yong: "Cannot Assert Financial Stability... Need to Monitor Impact" [Q&A]

October Monetary Policy Committee Press Conference
Lee Chang-yong: "Not a Definitive Statement on Financial Stability... Will Monitor Impact"
To Yeongkkeuljok: "Ultra-Low Interest Rates Won't Return... Must Consider Interest Burden"

Lee Chang-yong, Governor of the Bank of Korea, stated on the 11th, "I do not assert that financial stability has been confirmed," adding, "We need to observe the effects after the policy."

At a press conference held after lowering the base interest rate by 0.25 percentage points that day, Governor Lee said, "Since we need to observe how much the interest rate cut will affect housing transaction volumes and price growth rates, I do not assert that financial stability has been confirmed," and reiterated, "We need to see what impact the policy has after implementation."

He continued, "However, the positive aspect is that the government has a very strong will to stabilize household debt and has stated it will strengthen regulations if necessary. We also believe that by adjusting the pace of interest rate cuts, we can contribute to financial stability," he explained.

Regarding the evaluation that the timing of the interest rate cut was late, he said, "It is difficult to evaluate the interest rate decision immediately; please evaluate it after one year," and added, "To institutions criticizing that the rate cut was delayed, I want to ask, 'Did you expect household loans to increase by nearly 10 trillion won even without an interest rate cut?'"

He further stated, "I completely disagree with the view that it is difficult to positively evaluate the Bank of Korea's monetary policy because the Bank hesitated and failed to raise rates further over the past two years, which caused this situation (increase in household debt)," and assessed, "Our country achieved the 2% inflation target faster than major countries, and during that process, we managed real estate project financing (PF) defaults and foreign exchange market issues without major problems."

Regarding household debt management, he emphasized the need to expand the Debt Service Ratio (DSR) regulation in the medium to long term. Governor Lee said, "In the medium to long term, it is important that any loan is borrowed according to one's capacity," adding, "I think DSR regulation should be expanded in the medium to long term, but in the short term, there may be side effects, so it is reasonable for the government to judge based on the household loan situation."

The following is a Q&A with Governor Lee Chang-yong.

- What is the outlook of Monetary Policy Board members on the interest rate level within three months? Does the minority opinion indicate the possibility of a rate cut within three months?

▲Among the six Monetary Policy Board members excluding myself, five expressed the view that "it is appropriate to maintain the rate at 3.25% even after three months." The remaining one suggested keeping open the possibility of a cut below 3.25%. The five members believed that since it will take time to confirm the impact of this 25 basis point (1bp=0.01 percentage point) cut on real estate prices and household debt, decisions should be made cautiously while monitoring geopolitical situations, the U.S. presidential election, and future economic conditions. The one member noted that since the government's macroprudential policies have started to work and the government has expressed willingness to implement additional measures if necessary, the possibility of further cuts should be kept open.

▲At this Monetary Policy Board meeting, member Jang Yong-seong expressed the opinion that maintaining the rate at 3.5% is desirable. However, I cannot disclose his views on the three-month interest rate outlook, as conditional forecasts after three months are kept anonymous.

- Were there any concerns about household debt at this Monetary Policy Board meeting?

▲One member said it is better to wait and see and keep the rate unchanged, while the others had various views but basically agreed that "since an interest rate cut itself will affect real estate prices, it is better to make a slight cut and observe rather than not cut and just watch."

- What was the opinion of member Jang Yong-seong, who favored maintaining the rate?

▲He said it is still early to judge the effects of macroprudential policies, and although vulnerable groups and self-employed people are struggling, overall growth exceeds potential levels, so it is appropriate to maintain the rate and check the effects of macroprudential policies. Please check the minutes in two weeks for details.

- Household debt decreased in September compared to August but not significantly. Did you judge that financial stability has been confirmed with this level of slowdown? Is there a possibility of consecutive rate cuts in November?

▲Mortgage loans are determined by housing transaction volumes from two to three months prior, so they are lagging indicators. Looking at September's housing transactions, they are about half of those in July. The housing price increase rate in the Seoul metropolitan area is also about one-third of August's. We see meaningful progress including supply policies after the government's strengthening of macroprudential policies. Due to the influence of July and August transactions, it may rise until next month.

▲I do not think enough time has passed to confirm financial stability. One important policy is the interest rate cut. We need to observe how much the cut affects housing transaction volumes and price growth rates. I do not assert that financial stability has been confirmed. However, we need to see the impact after the policy. The positive point is that the government has a very strong will to stabilize household debt and has said it will strengthen regulations if necessary. We also can contribute to financial stability by adjusting the pace of rate cuts, so macroprudential policies should continue for the time being.

▲Regarding the possibility of a rate cut in November, five Monetary Policy Board members said that if the current state is maintained for three months including November, it is better to keep the rate unchanged. I will respond on behalf of the members.

- How do you view the evaluation of the cut as a 'hawkish cut'?

▲Since we consider financial stability when cutting rates, it can be interpreted as hawkish in that regard.

- In the August Monetary Policy Board meeting, you said private consumption and domestic demand were not significantly weak. Has the Bank of Korea's view on domestic demand changed? What is the background of the rate cut?

▲The biggest reason for lowering rates is that inflation has fallen below 2%, so the real interest rate is quite high and tight. If the economy were overheated, we would maintain tightness, but even though domestic demand is recovering, it is below potential growth, and economic growth itself is not much higher than potential growth, so there is no need to keep the base rate at a tight level unnecessarily. There is no significant change in the outlook for domestic demand.

- What are your thoughts on the criticism of a delayed rate cut?

▲There were many opinions that the Bank of Korea delayed the rate cut in August. Whether it was delayed depends on whether monetary policy focuses solely on domestic demand or also considers financial stability. We obviously consider financial stability. It is difficult to evaluate the rate decision immediately; please evaluate after one year.

▲In August, there was an internal opinion favoring a rate cut, but at that time, apartment transaction prices in Seoul started to surge rapidly, and there was a risk that real estate prices would rise uncontrollably, so preemptive measures were taken to avoid further stimulating housing sentiment. We are cooperating with the government to stabilize household debt to some extent, which is fortunate. To institutions criticizing the delay, I want to ask, "Did you expect household loans to increase by nearly 10 trillion won even without a rate cut in August?"

▲Another criticism is that "the Bank of Korea hesitated over the past two years in response to high inflation and failed to raise rates further, causing this situation (increase in household debt), so it is difficult to positively evaluate the Bank's monetary policy." I completely disagree. I think the inflation stabilization cycle has ended. Our country achieved the 2% inflation target faster than major countries and managed real estate project financing (PF) defaults and foreign exchange market issues without major problems. If we had raised rates more sharply amid inflation and PF default concerns, the pain for self-employed and domestic demand weakness would have been much worse. The relatively smaller rate hikes and rapid inflation control should be positively evaluated.

- How much impact do you expect this rate cut to have on Seoul housing prices?

▲Real estate prices and household debt are related not only to rate cut expectations but also to supply in the metropolitan area, construction costs, and underlying education issues. Therefore, rate cuts alone cannot control housing prices. Rate cuts may naturally raise prices, but policy coordination is necessary. The Bank of Korea should not be seen as an outsider in this area; the outcome can vary depending on how we adjust the pace of cuts. The government has shown strong will to stabilize household debt and real estate prices and said it will strengthen measures if necessary. Although difficult, I hope this time we achieve successful stabilization.

- You said the pace of rate cuts is more important. You also said you would be cautious about rate decisions within three months. If the current situation continues, is a rate cut in November possible?

▲Since we are data-dependent, it is difficult to comment here. We will comprehensively review data around late October, the November economic outlook, household debt stabilization trends, and metropolitan real estate prices before making a decision.

- Do warnings about the "Yeongkkeuljok" (those who borrowed to the maximum) still stand?

▲My past remarks were not specific predictions about real estate prices but warnings that interest rates are unlikely to return to the previous 0.5% level soon, so if you want to invest in real estate, do not expect low interest rates. In the U.S., inflation rose about 10%, and rates were raised significantly, so rate cuts must be fast until inflation falls. Compared to that, Korea raised rates less and inflation rose to about 6%, so one should not think that because rates abroad fall by 50bp, ours will too, or that borrowing is risk-free. Korea considers 'financial stability,' which is not present abroad, so if you are doing gap investment, you should consider how much you can bear.

- Can the rate cut compensate for weak private consumption?

▲Domestic demand consists of various components. Consumption growth in the second half is 1.8%, annualized at 1.4%, below the 2% potential growth but in recovery. However, there is significant polarization depending on self-employed status and income levels. We know household debt causes severe pain. Consumption rose from 1% in the first half to 1.8% in the second half, a low but recovering trend.

▲Regarding other domestic demand, facility investment may rise more than expected due to increased semiconductor equipment investment, while construction investment remains low. Overall economic growth is supported by exports, showing growth above potential. The third-quarter growth rate will be released at the end of this month, and when reviewing the November economic situation, we will consider uncertainties such as the U.S. presidential election results, U.S. soft landing prospects, China's stimulus effects, and IT sector conditions.

- What is your view on the perception that the Bank of Korea shifted the responsibility for financial stability to the government?

▲There is a perception that household debt responsibility is being shifted to the government with this announcement, but please do not think so. Macroprudential policies are not only implemented by the government but also include interest rate policies. The government's regulatory and supply policies are coordinated with interest rate policies.

- Is lowering the base rate amid slowing metropolitan housing prices likely to stimulate the real estate market?

▲Real estate price issues cannot be solved by macroprudential policies alone. Supply issues, education problems in Seoul, and other factors are complex. It will not be resolved quickly. While we pay attention to housing prices, managing household debt is more important if focusing on short-term goals. Since metropolitan housing prices involve many important factors, policy coordination is necessary. Housing prices are linked to household debt. The Bank of Korea has policy tools for household debt. Since rate cuts theoretically can increase household debt and affect real estate price expectations, we will adjust the impact carefully and coordinate with the government.

- Do you still see market interest rates as excessively low?

▲There were two reasons market rates were low. First, expectations of lower U.S. rates caused Korean rates to fall. This issue seems largely resolved. Second, concerns about financial stability given the rapid rise in metropolitan real estate prices made it difficult to lower rates quickly. Considering financial stability, market rates were excessively low. Lowering rates now may raise market expectations that rates will be cut further in November, which is a risk. However, the Bank of Korea will consider inflation and financial stability and adjust the pace of cuts accordingly.

- How do you think inclusion in the World Government Bond Index (WGBI) will affect the interest rate path?

▲It is good news. Many are interested in how the exchange rate will behave after WGBI inclusion. The actual inclusion will occur in November and be phased in over a year, so effects will appear with a lag. I am deeply moved because WGBI inclusion shows how important structural improvements are compared to short-term policies to attract foreign investors. Inclusion improves foreign investors' access to our market through foreign exchange market structural reforms. There was much disagreement among policymakers about whether this was appropriate. The foreign exchange market maintained old structures for various reasons despite Korea's economic scale and global image. Over the past two to three years, structural reforms led to inclusion, and the Bank of Korea contributed significantly. The investor base will shift toward long-term investors rather than speculative ones.

▲Regarding monetary policy, there is an advantage in more flexibly using the floating exchange rate system. Until now, Korea's debt was raised in foreign currency, which, when converted to won, increased burdens and credit risks. If government bonds and bank bonds can be sold to foreigners in won, even if exchange rate volatility occurs, the investor bears the loss, which is significant. There may be a preemptive effect of lowering government bond yields, and the floating exchange rate system can be used more flexibly.

- How much impact do you think this rate cut will have on resolving domestic demand weakness?

▲I do not think domestic demand is solid. Consumption is worse than last year, with significant polarization causing pain for self-employed and others. Growth improvement is slow, domestic demand is below potential, and many suffer. Amid this, we maintained high rates to target 2% inflation. Now that inflation has fallen below 2%, real rates are tight. If we do not worry about rising inflation, there is no need to keep real rates unnecessarily high, so this is a process of adjusting rates toward neutral.

- You have pointed out a vicious cycle between policy finance and rising housing prices. What is your view on the need for stronger regulations?

▲We need to distinguish timing. The criticism that policy finance increased household debt was made at the end of 2023. At that time, 70% of household loan increases were due to policy finance, so restraint was necessary. After the first half of this year, less than 30% of household loans were policy finance loans. The rest increased due to competition among banks rather than planned targets. The current increase in household debt is not mainly caused by policy finance.

▲Additional DSR regulations may inconvenience genuine borrowers. It is better to observe the effects of the first phase of macroprudential policies and then decide. In the medium to long term, borrowing according to capacity is important. Therefore, I think DSR regulation should be expanded in the medium to long term, but in the short term, side effects may occur, so it is reasonable for the government to judge based on household loan conditions.

- Is it necessary to lower rates to neutral levels by next year?

▲If rates do not fall to neutral, potential growth will fall below 2%. Neutral rate is the level needed to maintain potential growth. Rates were above neutral to lower inflation. If the base rate remains above neutral, it is difficult to keep inflation at 2%, so we aim to lower it.

▲Some say 2% potential growth is good, but with structural reforms, growth above 2% is possible. The Bank of Korea is not satisfied with 2% growth given low birth rates and aging. Without restructuring, potential growth could fall to zero percent levels, so restructuring is necessary.

- Banks are raising loan rates despite the Bank of Korea lowering the base rate. How do you view this mismatch?

▲I do not see banks raising household loan rates as a mismatch. Lowering rates to channel funds into real estate is undesirable. However, differentiating rates by loan type is not a mismatch. This helps change Korea's asset concentration in household debt and real estate.

- What are the conditions for further rate cuts?

▲First, we will consider inflation, which is expected to remain similar unless there is a major change like the Middle East crisis. Second is financial stability. Third, we will comprehensively assess whether economic growth is maintained as expected.

- There are external variables such as geopolitical crises and oil price concerns. How might abnormal oil price movements affect the current interest rate direction?

▲We are closely monitoring the Middle East situation, which is unpredictable. If oil prices rise due to the crisis, we will comprehensively consider how to respond with interest rates. One reason the statement mentioned uncertainty is because the Middle East situation is hard to predict.