Unexpected Cut in BOK Base Rate... "Injecting Money to Revive Economy" (Comprehensive)

Bank of Korea Cuts Base Rate Twice in a Row Amid Growth Slowdown Concerns
Next Year's Growth Forecast at 1.9%, Below Potential Growth Rate
Preemptive Rate Cut Poses Risks Including Forex Market Instability

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul on the 28th. Photo by Joint Press Corps

The Bank of Korea surprised the market by cutting the base interest rate twice in a row. This is interpreted as a rapid rate cut to stimulate the economy amid growing concerns about economic sluggishness. The forecast for next year's economic growth rate was revised downward from the previous 2.1% to 1.9%, which is below the potential growth rate (2.0%).

Surprising the Market with a Sudden Base Rate Cut

The Monetary Policy Board of the Bank of Korea announced on the morning of the 28th at the Bank of Korea headquarters in Jung-gu, Seoul, that it had set the base interest rate at 3.00% per annum. This is a 0.25 percentage point cut from the previous 3.25%.

The Monetary Policy Board had lowered the base rate by 0.25 percentage points from 3.50% to 3.25% on the 11th of last month, marking a pivot in policy for the first time in 3 years and 2 months. The market expected the Bank of Korea to hold rates steady this month to observe the effects of the rate cut, but the Bank chose to cut rates twice consecutively.

At the time of last month's cut, Lee Chang-yong, Governor of the Bank of Korea, stated that "5 out of 6 Monetary Policy Board members believe the base rate should be maintained at 3.25% even three months later," indicating a reluctance to rush monetary easing.

The Bank of Korea's unexpected rate cut is interpreted as a response to the very poor recent economic conditions in South Korea. The country's economic growth rate for the third quarter was 0.1%, far below the expected 0.5%. The slowdown in export growth of key items such as semiconductors, automobiles, and secondary batteries, which had supported the economy, is the cause.

The problem is that this trend is likely to continue into next year. Experts believe that if the tariff policies of the second Trump administration are fully implemented next year, they will significantly reduce South Korea's exports and economic growth rate.

The Korea Institute for Industrial Economics and Trade, a government research institute, estimated that if the universal tariffs (10-20%) promised by President Trump are actually imposed, South Korea's exports to the U.S. could decrease by up to 14% (about $9.3 billion). This would reduce South Korea's economic growth rate by 0.2 percentage points. The Hyundai Research Institute analyzed that if the U.S. wages a tariff war not only with China but with all countries worldwide, South Korea's economic growth rate could decrease by as much as 1.1 percentage points in the worst case.

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee meeting held on the 28th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

Next Year's Growth Forecast Lowered to 1.9%, Concerns Over Low Growth

The Bank of Korea's downward revision of next year's economic growth forecast was also cited as a reason for the rate cut. In its revised economic outlook released that day, the Bank lowered the forecast for next year's economic growth from 2.1% to 1.9%. The 1.9% figure is below the Bank's estimate of South Korea's potential growth rate of 2.0%, suggesting the possibility that the Korean economy is entering a low-growth phase. This year's growth forecast was also lowered from 2.4% to 2.2%, and the forecast for next year's consumer price inflation was reduced from 2.1% to 1.9%.

Private research institutions have also increased their negative outlooks, predicting that next year's economic growth will fall short of the Bank's 1.9% forecast. Goldman Sachs projected South Korea's economic growth at 1.8% next year. Kwon Gu-hoon, Senior Economist at Goldman Sachs, said, "The tariff policies of the second Trump administration will be a downside risk for the Korean economy," adding, "Export weakness has already begun in the second half of this year, and investment is likely to decrease accordingly."

Morgan Stanley also forecast South Korea's growth rate at 1.7% for next year, citing weak domestic demand and Trump's tariff policies as negative factors. Other major investment banks (IBs) such as Nomura Securities, JP Morgan, Barclays, and Citi also lowered their growth forecasts for South Korea next year to the high 1% range.

Professor Son Jong-chil of the Department of Economics at Hankuk University of Foreign Studies said, "Corporate investment is shrinking, and the pace of base rate cuts is slower than initially expected, so next year looks challenging for our economy," adding, "Without government intervention such as issuing government bonds, it will be difficult for next year's economic growth rate to exceed 2.0%."

Jung-woo Park, Economist at Nomura Securities, evaluated the rate cut as "a base rate cut to mitigate downside risks to next year's growth amid growing concerns about exports following the U.S. presidential election."

Lee Chang-yong, Governor of the Bank of Korea, is striking the gavel at the Monetary Policy Committee meeting held on the 28th at the Bank of Korea in Jung-gu, Seoul. Photo by Joint Press Corps

Rapid Rate Cuts May Cause Foreign Exchange Market Instability

Concerns are also rising about side effects from the faster-than-expected rate cuts. The biggest issue is the exchange rate. Since former President Trump's election victory earlier this month, the won-dollar exchange rate has surged sharply, surpassing the 1,410 won level intraday on the 13th, reaching the highest level in two years. Since then, it has not fallen significantly and remains in the low 1,390 won range.

It is analyzed that Trump's tariff policies could rekindle inflation and slow the pace of rate cuts, which has led to a stronger dollar and has been reflected in South Korea's foreign exchange market. In this situation, further base rate cuts could cause the dollar's value to rise even more, leading to a renewed surge in the exchange rate. If the exchange rate rises too much, it could stimulate import prices and negatively impact the Korean economy.

Professor Kim Jin-il of the Department of Economics at Korea University said, "The Bank of Korea's two goals of price stability and financial stability are in conflict, and at this point, the biggest risk is the exchange rate."

There are also concerns about a mismatch with the U.S., which has turned cautious about rate cuts. In the minutes of the Federal Open Market Committee (FOMC) meeting released on the 26th, members agreed on the need to be cautious about future rate cuts. They cited the ongoing strength of the U.S. economy and uncertainties about the 'neutral rate' level as reasons to moderate the pace of rate cuts.