Bank of Korea Monetary Policy Committee Lowers Base Rate from 3.50% to 3.25%
Influenced by US Rate Cut, Price Stability, and Weak Domestic Demand
Governor Lee Chang-yong: "Monitoring Impact of Rate Cut, Discussing Further Reductions"
The Bank of Korea (BOK) has abruptly cut its base interest rate by 0.25 percentage points. The pivot (policy shift) from the monetary tightening stance that began in August 2021 to easing has started after 3 years and 2 months.
This rate cut by the BOK is evaluated to have been decided as major countries such as the United States and Europe began lowering their rates, and domestic inflation also showed clear signs of stabilization. The sluggish domestic demand is also cited as a reason why the BOK can no longer maintain the historically longest high interest rate stance. It is judged that it is time to inject money to boost the economy. However, since the excessive household debt problem still remains, it is expected that there will be no additional cuts within this year.
BOK Cuts Base Interest Rate by 0.25 Percentage Points, Pivot Begins After 3 Years and 2 Months
Lee Chang-yong, Governor of the Bank of Korea, is presiding over the Monetary Policy Direction meeting of the Monetary Policy Committee held on the 11th at the Bank of Korea in Jung-gu, Seoul. The Bank of Korea ended its monetary tightening stance, which began in August 2021 with a 0.25 percentage point increase, and lowered the rate by 0.25 percentage points, shifting to a more accommodative stance for the first time in 3 years and 2 months. Photo by Joint Press Corps
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 decided to set the base interest rate at 3.25% per annum. This is a 0.25 percentage point decrease from the previous 3.50%. Board member Jang Yong-seong was the sole dissenting voice, favoring a rate freeze.
The last time the BOK cut the base interest 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. Subsequently, as 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 base rate rose to 3.50% in January last year, and since then, the BOK maintained the longest-ever consecutive rate freeze of 13 times 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.
Regarding the 3-month conditional forward guidance, the majority of MPB members expressed the opinion that the current rate of 3.25% should be maintained even after 3 months. BOK Governor Lee Chang-yong said at a press conference after the meeting, "Among the six Monetary Policy Board members excluding myself, five suggested maintaining the base rate at the current level of 3.25% after 3 months." He added, "The remaining one member suggested keeping the possibility open for a cut to a level lower than 3.25%."
He explained, "Five members expressed the view that it will take time to confirm the impact of the rate cut on financial stability factors such as real estate prices and household debt, and that the results of the U.S. presidential election and the development of geopolitical risks should also be observed." On the other hand, "One member said that since the government's macroprudential policies have started to work and the government has announced additional measures if necessary, the possibility of further rate cuts should be kept open to respond to downward pressure on domestic demand," he explained.
Greater Room for Monetary Policy Shift After U.S. Big Cut
The BOK ended its long-standing high interest rate stance because various obstacles that had constrained rate cuts, such as the U.S. rate cuts and price stability, have been removed. 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, according to analysis.
Joo Won, head of economic research at Hyundai Research Institute, explained, "The U.S. made a big cut, and major countries such as Canada and Europe had already lowered their rates earlier. It would have been difficult for the BOK to insist on high rates any longer."
The clear stabilization of inflation is also a factor that led 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 also well below the BOK’s inflation target of 2.0%. Governor Lee cited the biggest reason for this rate cut as "there is no need to maintain an unnecessarily tight level when the inflation rate has fallen."
Lee Chang-yong, Governor of the Bank of Korea, is speaking at a press conference held after the Bank of Korea's Monetary Policy Committee lowered the base interest rate by 0.25 percentage points on the 11th. (Photo by Bank of Korea)
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 household loan balance of the five major domestic banks last month was 730.9671 trillion won, an increase of 5.6029 trillion won from the previous month. After recording the largest monthly increase ever of 9.6259 trillion won in August, the increase narrowed in September.
Governor Lee evaluated the household loan trend as "meaningful progress." He analyzed, "Mortgage loans are determined by housing transaction volumes from 2 to 3 months prior. In September, apartment transaction volume was half of July’s, and the housing price increase rate in the metropolitan area was one-third of August’s."
The sluggish domestic demand is also a background for the rate cut. In the second quarter, South Korea’s real gross domestic product (GDP) contracted by 0.2% quarter-on-quarter. This quarterly contraction is the first 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.
The Korea Development Institute (KDI) diagnosed in its ‘October Economic Trends’ report released the day before that "recently, our economy continues to show a favorable export trend, but the recovery of domestic demand is delayed mainly due to construction investment, limiting economic improvement." In its September economic trends report, KDI also evaluated, "The recovery of domestic demand has not materialized as retail sales and construction investment remain sluggish," and "the high interest rate stance delays domestic demand recovery, limiting economic improvement."
Some MPB members hinting at the possibility of a base rate cut is also cited as a background for the October rate cut. Shin Seong-hwan, a BOK Monetary Policy Board member, said at a press conference on the 25th of last month, "Our economy does not have the luxury to wait until the housing price rise slows down significantly," expressing the opinion that a base rate cut is necessary.
Low Possibility of Additional Cuts Within the Year Due to Financial Stability Concerns
However, the market sentiment is that additional rate cuts by the BOK within this year will not be easy because the household debt problem is still ongoing. South Korea’s household debt-to-GDP ratio stood at 91.1% as of the second quarter of this year, still the highest level in the world. The BOK believes that lowering the household debt ratio to around 80% would reduce the burden on the economy.
Regarding the pace of future rate cuts, Governor Lee said, "We will decide while monitoring the financial stability situation." He emphasized, "We are not in a situation like the U.S. where the base rate can be cut by 0.5 percentage points at once." He explained, "The U.S. had inflation rise over 10% and raised rates by more than 5 percentage points, so it is natural that the pace of rate cuts is fast." On the other hand, "We raised rates by 3 percentage points, so people should not borrow money thinking that we will cut rates as much as the U.S. does," he stressed.
Professor Ahn Dong-hyun of Seoul National University’s Department of Economics said, "It is true that the environment for rate cuts has been created with the exchange rate falling and inflation dropping, but considering household debt, it is a situation where cuts should not be made," and predicted, "The BOK will only cut the base rate once this year."
On the other hand, there is also an opinion that if the U.S. Federal Reserve cuts the base rate again at the Federal Open Market Committee (FOMC) meeting on November 7, the BOK will also cut the base rate at the MPB meeting on November 28. The U.S. has two remaining FOMC meetings including December 18, and the BOK’s last MPB meeting is on November 28.
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