High Exchange Rate Hinders Interest Rate Cut... BOK Holds Base Rate at 3.0% (Update)

Bank of Korea Holds Base Rate at 3.00% per Annum
High Exchange Rate Makes Third Consecutive Cut Difficult
Possible Rate Cut Next Month Due to Economic Slowdown

The Monetary Policy Committee (MPC) of the Bank of Korea announced on the morning of the 16th at the Bank of Korea headquarters in Jung-gu, Seoul, during the first monetary policy direction meeting of the year, that the base interest rate will be maintained at the current level of 3.00%. Lee Chang-yong, Governor of the Bank of Korea (center), is presiding over the meeting. Photo by Bank of Korea

The Bank of Korea has kept the base interest rate steady at 3.00% per annum. Although it had cut the base rate twice consecutively due to concerns over economic slowdown, this time it maintained the rate at the current level. Concerns that further rate cuts could push the already high won-dollar exchange rate even higher were reflected in this decision. The emerging calls in the United States to slow down the pace of rate cuts also influenced the decision. However, there is a prevailing expectation that the Bank of Korea may cut the base rate again next month to revive the sluggish domestic economy.

The Monetary Policy Committee (MPC) of the Bank of Korea announced on the morning of the 16th at the Bank’s headquarters in Jung-gu, Seoul, during the first monetary policy meeting of the year, that it would keep the base rate at the current level of 3.00%. The MPC had lowered the base rate by 0.25 percentage points at the previous meeting held on November 28 last year. Including the cut in October, the rate was reduced twice consecutively before returning to a hold this time.

The high exchange rate is cited as the biggest reason for the Bank of Korea’s decision to hold the base rate. The won-dollar exchange rate surged by more than 50 won from 1,394.7 won at the end of November last year to the 1,450 won level currently. Among major world currencies, except for the Russian ruble which is affected by the ongoing war, the won has depreciated the most. Excessive rise in the won-dollar exchange rate not only pushes up consumer prices but also causes various economic damages such as sluggish domestic demand and reduced production. The global dollar strength and domestic political turmoil caused by martial law and impeachment are the main reasons for the sharp rise in the exchange rate, but concerns that further rate cuts by the Bank of Korea could fuel the exchange rate increase again have gained consensus among MPC members.

Since the base rate was cut twice consecutively earlier, there is also an assessment that the MPC decided to pause the cuts this time to review the domestic economic situation and discuss further cuts at the next meeting. Heo Ji-su, a senior researcher at Woori Financial Management Research Institute, said, "The Bank of Korea considered the current situation of sustained high exchange rates and reviewed the economic effects of the two consecutive cuts before deciding to hold the base rate this month."

The slowing pace of rate cuts by the U.S. Federal Reserve (Fed) is also considered a factor that led the Bank of Korea to pause its rate cuts. The U.S. economy continues to perform well, and concerns over rising inflation have increased around the inauguration of Donald Trump’s second-term administration, leading to a prevailing view that there will be no rate cuts for the time being. Cho Young-moo, a research fellow at LG Economic Research Institute, evaluated, "Considering the burden of the elevated exchange rate and the cautious atmosphere regarding the Fed’s rate cuts, the Bank of Korea appears to have held the base rate this month."

However, many expect the Bank of Korea to resume cutting the base rate next month to stimulate the sluggish domestic economy. Major domestic and international research institutions forecast that Korea’s economic growth rate this year will fall below the potential growth rate of 2.0%. There are also growing concerns that low growth will become entrenched due to export slowdown and weak domestic demand. Lim Jae-kyun, a researcher at KB Securities, said, "The Bank of Korea held the base rate this month due to the burden of the exchange rate," but added, "Considering concerns over economic slowdown, there is a possibility of another rate cut at the February MPC meeting."