Bank of Korea Governor Lee Chang-yong: "Economic Growth Uncertainty High... Next Year's Forecast May Also Change" [Q&A]

November Monetary Policy Committee Press Conference
Trump-Driven Uncertainty and Export Slowdown Noted
Lee Chang-yong "Many Tools to Manage Exchange Rate Volatility... Need to Adjust Speed Rather Than Level"
Possibility of Additional Rate Cut Within 3 Months Divides Opinion 3 to 3

Lee Chang-yong, Governor of the Bank of Korea, stated on the 28th, "With the new U.S. administration taking office, uncertainty will increase depending on what policies are implemented and in what order," adding, "There is a high possibility that the forecast figures will change in the February outlook next year."

Yonhap News

At a press conference held after lowering the base interest rate by 0.25 percentage points, Governor Lee explained, "There was relatively little disagreement among the Monetary Policy Committee members regarding inflation and household debt, but there was considerable deliberation and discussion about the trade-off between growth and foreign exchange market stability," and added, "The Monetary Policy Committee deemed it appropriate to further lower interest rates in response to downward pressure on the economy and to take government and market stabilization measures in case of exchange rate fluctuations."

Regarding the exchange rate fluctuating at a high level, he said, "We have sufficient foreign exchange reserves for volatility management and ample capacity to use them," and added, "We are discussing expanding the swap amount with the National Pension Service and extending the duration."

He continued, "It is difficult to call a specific exchange rate level a crisis because the structure has changed significantly," and added, "We are no longer a country with a large amount of external debt, and domestic investors' overseas investments have increased substantially, so we need to control the speed rather than the level of the exchange rate."

The forward guidance reflecting the Monetary Policy Committee members' interest rate outlook within the next three months was split 3 to 3. Governor Lee said, "Three members expressed the opinion that considering the neutral interest rate level of our economy, the pace of rate cuts should be gradually adjusted, taking into account the room for additional rate cuts," and "The other three members decided to keep open the possibility of cuts depending on changes in the outlook, given the significant uncertainty in both domestic and external economic conditions and economic forecasts."

Below is a Q&A session with Governor Lee Chang-yong.

- What is the forward guidance on the interest rate outlook within the next three months by the Monetary Policy Committee members?

▲Among the six Monetary Policy Committee members excluding myself, three said there is a possibility that the base interest rate will be maintained at 3% within three months, while the other three said the possibility of a rate cut should be kept open. The three members expressed the opinion that considering the neutral interest rate level of our economy, the pace of rate cuts should be gradually adjusted, taking into account the room for additional rate cuts. The other three members decided to keep open the possibility of cuts depending on changes in the outlook, given the significant uncertainty in both domestic and external economic conditions and economic forecasts. I emphasize that all of this is conditional on economic circumstances.

- What changes have occurred since the October Monetary Policy Committee meeting?

▲There have been two major changes since October. One is the uncertainty regarding the U.S. presidential election results. The Republican Party's unexpected sweep of the presidency and both houses of Congress, known as the Red Sweep, exceeded expectations. This election result has expanded policy uncertainty globally. The second is that upon reviewing whether the significant decline in export growth volume in the third quarter was temporary or structural, we judged that structural factors, such as intensified export competition from rival countries, played a major role. Accordingly, we revised downward both next year's goods exports and growth rate. These two changes were reflected in this interest rate decision. The uncertainty about exports and the adjustment of growth forecasts are new information and represent a significant change.

- You forecast next year's economic growth rate at 1.9% and 1.8% the year after, both below the potential growth rate (2%). Has the potential growth rate itself declined?

▲The 1.9% growth rate forecast for next year is highly uncertain but is the best estimate we could make. Uncertainty will increase depending on what policies the new U.S. administration implements and in what order. Therefore, there is a high possibility that the figures will change in the February 2024 outlook. The 2025 forecast is also set at 1.8%, but volatility in the numbers is expected. I hope less weight is placed on the 2026 growth forecast. If we consider the potential growth rate as 2%, the 2025 growth rate is below potential. We will be able to see new estimates of the potential growth rate when they are released at the end of the year.

- How much economic recovery do you expect next year from the interest rate cut?

▲According to macroeconomic models, a 25 basis point (1bp = 0.01 percentage points) cut is estimated to raise the economic growth rate by 0.07 percentage points. We should not look only at temporary effects; the impact may vary depending on how much and how quickly rates are cut.

- You lowered the growth forecast to the 1% range through the year after next. Two consecutive rate cuts are the first since the financial crisis. It seems export risks were heavily factored into this decision. Can rate cuts solve export problems?

▲It is true that the economic growth forecast was lowered due to exports. However, the rate cuts were not targeted at exports. As the export growth rate was lower than expected, we lowered the economic outlook and anticipated that the warmth transmitted from exports to domestic demand would decrease, so we cut rates to stimulate domestic demand. Exports are heavily influenced by external conditions. A significant part of the current decline in export growth is due to a decrease in our country's international competitiveness, which should be addressed through industrial policies and structural reforms to strengthen competitiveness. Interest rates will play a role in supporting economic growth.

- In the previous Monetary Policy Committee forward guidance, only one member kept open the possibility of a cut within three months. There is an evaluation of a 'surprise cut.'

▲I emphasize again that forward guidance is conditional. If it is not considered conditional, it can be disappointing. Just as forecasts change, new information naturally leads to changes. We do not think we should maintain forward guidance simply because we mispredicted the U.S. election results. Regardless of timing, we respond to new information. I hope this occasion clarifies that the three-month forward guidance is conditional.

- When deciding on consecutive rate cuts, what impact did you expect on the exchange rate? How will market stabilization measures be specifically implemented if exchange rate volatility expands?

▲We discussed more about the impact of exchange rate volatility than the level of exchange rate fluctuations on the rate decision. In conclusion, while we pay attention to volatility, we have sufficient foreign exchange reserves for volatility management and ample capacity to use them. We are discussing expanding the swap amount with the National Pension Service and extending the duration. If exchange rate volatility increases and the exchange rate rises, the National Pension Service itself may increase hedging to fix profits. We are adjusting the swap amount to facilitate hedging. We will use various means to mitigate volatility through policy cooperation with the government.

- Is this rate cut an insurance cut due to President Trump's tariffs or a full-fledged rate cut? The Bank of Korea said it would normalize rates to the neutral rate by next year. Are you considering a moderate rate cut?

▲Because interest rates rose significantly in the past to curb inflation, current interest rates are on a downward trend. Basically, we are in the process of normalizing rates. Whether Trump's tariff policies will expand to Mexico, Canada, China, etc., affects our exports and economy, so the issues are intertwined.

▲Given the high uncertainty and that we are normalizing from high rates, it is not yet time to say whether rates will fall to the neutral level. We will decide while observing how our exports change and whether the economy will decline further. Please understand that this decision was made to accelerate the pace of rate cuts due to greater-than-expected downward pressure on the economy.

- Although the decision focused on growth, there are concerns that lowering the base rate may encourage household debt growth.

▲It is true that lowering rates raises expectations and increases household debt. However, even before the rate cuts, since May or June this year, market interest rates fell anticipating U.S. rate cuts, while policy rates did not fall, leading to a surge in household debt. Fortunately, the rate was held steady in August, and the government's macroprudential policies helped curb the upward momentum.

▲There are criticisms that rate cuts were delayed, but the pause in August helped stabilize household debt and prevent real estate prices from rising. In November, household debt remained around 5 trillion won, and it seems to be declining in December. Based on the evidence that household debt is stabilizing for the time being, we implemented the rate policy. However, we will monitor whether this stabilization continues and how additional cuts might affect the situation, adjusting the timing of rate cuts accordingly.

- Although the current exchange rate level is high, is it not a crisis? Are the exchange rate level and volatility manageable?

▲It is difficult to call a specific exchange rate level a crisis because the structure has changed significantly. We are no longer a country with large external debt, and domestic investors' overseas investments have increased substantially, changing the structure of our foreign exchange market. The speed of exchange rate changes, rather than the level, can cause frictions and instability in financial markets, so speed must be controlled. Ahead of the U.S. election, the "Trump trade" caused a rapid depreciation of the won, but it is now stabilizing. Recently, the won's depreciation speed is not as severe compared to other currencies. Meanwhile, the yen and yuan are under the most depreciation pressure. We are adjusting the speed and have sufficient will and means to do so.

- After the U.S. election, the monthly average exchange rate volatility was about 0.3%. If volatility is low, is it okay for the exchange rate to keep rising?

▲It could be either way. Even if it rises slowly, the exchange rate level itself affects inflation, so the level may partially influence depending on our inflation. Also, even slow rises can affect investor sentiment if they exceed certain levels. We need to consider all factors comprehensively. It is not about a specific exchange rate level but about comparing movements with other currencies at the time. It is difficult to state a general principle. This comprehensive consideration is why monetary policy is called an art, not a science.

- Some argue that the Bank of Korea should have cut rates earlier. Exchange rates must have been a major consideration in the rate decision. Did you cut rates despite exchange rate burdens?

▲I repeat that the criticism of delay is premature. Please evaluate after about a year, considering growth and financial stability together. Personally, I think the pause in August helped stabilize financial stability and was beneficial for policy. Central banks must consider not only growth but also financial stability. I hope people do not think pessimistically. Export volumes are historically high, but export growth has slowed more than expected, which requires effort.

▲We were concerned about household debt and financial stability in August and September, but the government's strong macroprudential policies, especially on loans, have stabilized the situation. Thanks to these policies, concerns about financial stability have somewhat eased at today's level. Exchange rate volatility remains a concern, but fortunately, the rapid depreciation phase due to the Trump trade has ended, allowing for policy management. Short-term burdens have lessened, but we must watch the situation long-term. The foreign exchange market may experience increased volatility due to external factors.

- You mentioned expanding the foreign exchange swap with the National Pension Service. The current scale is about $50 billion. Are there plans to double or triple it?

▲Since discussions are ongoing, I cannot specify the amount or timing. It will not be several times larger but will increase significantly. The National Pension Service will find it easier to hedge against exchange rate volatility.

- Due to banks raising their spread rates, market interest rates rose last month. Some say base rate changes are ineffective. What is your view on the spread rate trend?

▲Compared to a year ago, rates have fallen significantly. Monetary policy does not adjust daily to influence rates. Rates fall during the normalization process. The recent one-month rate increase occurred because expectations for rate cuts from May grew, and market rates fell significantly afterward. The market had already priced in about a 50bp cut. We need to see when expectations for monetary policy shifts began. Especially in controlling household debt, rising spread rates are necessary costs to ensure financial stability. Once financial stability is secured, spread rates may decline from early next year, so please look at the long term. Monetary policy alone is not sufficient, but it helps control inflation and stimulate the economy.

- Initially, the GDP gap (potential GDP minus actual GDP) was expected to turn positive early next year. It seems difficult to achieve this soon. Have we entered a long-term low-growth phase? When can the gap turn positive?

▲We initially expected the GDP gap to close by early 2025, but with the downward revision of growth rates, the GDP gap will likely remain negative until the end of this year, though not by a large margin. Revising the GDP gap requires revising the potential growth rate, so the timing of the positive GDP gap has been delayed compared to August. Although uncertainty remains high for next year and the year after, the potential growth rate is indeed declining rapidly. Short-term economic responses are necessary, but discussions on structural reforms to prevent the decline in potential growth are also needed. The recent rebound in birth rates this month is encouraging.

- The monetary policy direction statement omitted the phrase 'carefully' when considering rate cuts. Does this mean you plan to adjust rates quickly to the neutral rate?

▲Financial stability concerns, real estate, and household debt issues that were previously worrisome have eased, and inflation has fallen significantly below the target. Because concerns about inflation and financial stability have lessened compared to before, we removed the word 'carefully' regarding the pace of rate cuts. However, concerns about the exchange rate have increased, leading to much deliberation this time.

- The U.S. Personal Consumption Expenditures (PCE) data for October was released early today. What is your outlook on U.S. inflation and interest rate policy? Is there a possibility the Federal Reserve will return to tightening?

▲There are many views on the U.S. economy. Generally, the international economic community recognizes that the U.S. economy alone has a high growth rate. This may slow the pace of inflation decline more than expected. Additionally, the new Trump administration's policies may increase inflation, which is the basic perception. The degree of this depends heavily on who becomes Treasury Secretary, so it is difficult to generalize. From our perspective, we keep in mind that U.S. rates may not fall as quickly as six months ago.

- There are recent rumors about Governor Lee becoming the next Prime Minister.

▲Given the challenging economic situation, it is most important to faithfully carry out current duties.

- This is the last monetary policy meeting of the year. Are there plans to extend or formalize forward guidance to a six-month or one-year horizon?

▲We are internally considering various options. We have not had detailed consultations with Monetary Policy Committee members and are conducting pilot tests internally. Even with good intentions, if the market does not perceive it as conditional, confusion arises. Quarterly economic forecasts are also conditional, and if they are wrong, the market criticizes heavily. Some say it is safer to introduce such measures when the gap between the market and us narrows. The timing will depend on how much the market can accept conditional forward guidance and quarterly economic forecasts.