Key interest rate frozen, but maybe not for long

The central bank froze the key interest rate yesterday in a bid to gauge the impact of its surprise rate cut in July on the local economy amid the protracted euro zone debt crisis.

As widely expected, Bank of Korea Gov. Kim Choong-soo and his fellow policy makers held the benchmark 7-day repossession rate steady at 3 percent for August. The move followed the BOK’s quarter-percentage-point rate reduction in July, the first cut in more than three years.

Analysts said that slowing economic growth and easing inflationary pressure are likely to give the BOK room to cut the rate further in the near future.

The unanimous decision came as exports, one of the main growth drivers of the Korean economy, faltered, and annual inflation growth eased to a 12-year low in July, running below the BOK’s inflation target band of 2-4 percent.

The BOK chief presented a bleak outlook for growth, saying that downside risks predominate, beset by the euro zone debt turmoil and economic slowdowns in emerging countries.

“Korea’s economic growth decelerated due to lackluster exports and domestic demand .?.?. The pace of global recovery is expected to be very moderate,” Kim said at a press conference.

He played down recently-raised concerns about deflation.

“Inflation expectations are weakening,” Kim said. “But Korea is not in a situation where it needs to worry about deflation risks.”

As inflation growth eased to within the 1 percent range, experts warned that Korea may experience deflation in terms of asset prices, especially given the high indebtedness of households and the tepid property market.

The BOK said that consumer inflation is expected to remain low for the time being despite potential upward risks, including hikes in public utility fees and unstable grain prices.

“If the BOK had cut the rate for a second straight month, economic agents would have cemented their bleak assessment of the Korean economy, which would have been bad enough to warrant a back-to-back cut,” said Kong Dong-rak, a fixed-income analyst at Taurus Investment & Securities. “The rate freeze came as the BOK is waiting to see the impact of monetary easing steps that will be taken by the U.S. and Europe before it decides to go ahead with a second rate cut.”

Following the decision, bond futures sharply declined on investors’ profit taking and the local currency appreciated against the dollar. Returns on Treasury bonds have been declining on expectation of a rate cut.

The protracted euro zone debt crisis and China’s slowing economy are blurring the prospects of the Korean economy, which grew a mere 0.4 percent in the second quarter from the previous three months.

Exports dropped 8.8 percent in July from a year earlier, the sharpest decline since September 2009. Imports fell for the fifth straight month as domestic demand continues to weaken.

The BOK’s 2012 growth outlook was lowered to 3 percent from 3.5 percent. Finance Minister Bahk Jae-wan and the BOK chief earlier hinted that the full-year growth may even dip lower.

Central banks in the euro zone and the U.S. did not take quantitative easing steps this month, but expectations are growing that they will do so in September to help the global economy get back on track.

Amid the slowing economy, the country’s headline inflation grew 1.5 percent on-year in July, its slowest pace in 12 years. The BOK’s 2012 inflation projection stands at 2.7 percent and the bank aims to keep its median inflation target at 3 percent for 2010-2012.

Rising global grain prices are raising fears that the risks of “agflation” may grip Korea, which heavily relies on imported grains and other agricultural products.

The BOK said that recent gains in grain prices will likely serve as upward pressure on consumer prices after the end of this year, but their impact on inflation would not be large.
Analysts said that once the BOK softened its monetary stance last month, the question of another rate cut would boil down to a case of when not if.

“A quarter-percentage-point rate cut is expected in September or October, given the need to shore up sluggish domestic demand,” said Hong Jung-hye, a fixed-income analyst at Shinyoung Securities. Yonhap