BOK trims interest rate to Blue House’s relief
The Bank of Korea yesterday shaved 0.25 percentage points off the key interest rate, bringing it from 2.5 percent to 2.25 percent.
The decision, and the size of the reduction, matched market expectations.
This is the first monetary easing in 15 months since the central bank lowered the rate from 2.75 percent in May last year. The rate is now its lowest in nearly four years. The last time the monetary policy rate was this low was in October 2010.
The question now is whether there will be another rate cut anytime soon. But at this point, the Bank of Korea governor, Lee Ju-yeol, considers it unlikely.
Many market analysts predicted that the central bank, pressured by the new economic team led by Finance Minister Choi Kyung-hwan, would cut the rate 0.25 percentage points. But some say that for the economy to actually feel the impact of a rate cut, it needs to be lowered by 0.5 percentage points.
Regarding this issue, Lee said he is in wait-and-see mode.
“The main reason we have decided to lower the key policy rate was a pre-emptive move targeted at preventing downward growth risks from becoming real,” Lee said at the central bank’s headquarters yesterday during a press conference held after the monthly monetary policy committee meeting.
“When the Sewol tragedy occurred [in April], the central bank saw that although it would definitely have an impact on the domestic market, the impact would not last long,” Lee said. “But our study in July showed that the psychological withdrawal was much more severe than what we projected and that is why we decided to lower the rate.”
Lee acknowledged that even though this year’s growth outlook was lowered from 4 percent to 3.8 percent last month, such growth represents a mild recovery.
“The severely withdrawn sentiments have become the major obstacle to the recovery of the domestic market and such sentiment needed to be reversed to propel a recovery,” Lee said. “When conditions change, there’s no choice but to change the countering policy as well.”
Lee noted that the lowering of the rate should help boost the economy.
“Analysis shows that when the rate is lowered, economic growth will be raised as spending and investment is spurred,” Lee said.
“Complemented with the government’s policies, we expect the effect to be even bigger. We expect the lowering of the policy rate will primarily improve sentiment and with it help maintain the recovery’s momentum.
“Based on past models, when you lower the policy rate by 0.25 percentage points, in the first year the economic growth makes an additional expansion between 0.05 percentage points and 0.1 percentage points.”
When asked if he believes the economy has gotten worse since the central bank lowered its outlook last month, Lee said no.
“It’s only been a month since we have made the change on our outlook and our stances haven’t changed since,” Lee said. “One could say that there was a sharp change if we made a decision that contradicted the signal we sent out [to the market] a month ago.
“I would like to point out that when looking back at our communication process, in June we sent the signal that we wouldn’t raise the interest rate and in July we stressed that the downward risks had expanded. After that we have made sufficient efforts in trying to communicate with the market regarding the central bank’s monetary policy.”
Lee also dismissed concerns over Korea entering deflation.
According to Statistics Korea earlier this month, the nation’s consumer prices grew 1.6 percent year-on-year in July. This was a slight drop from the 1.7 percent reported in June. Although consumer prices grew when compared to June, up 0.1 percent, the prices of most goods fell while food prices expanded from a year earlier.
Meanwhile, the GDP in the second quarter retreated compared to the first three months, largely due to shrinking consumer spending. In the second quarter, the economy grew 0.6 percent, a drop from 0.9 percent in the first quarter. Consumer spending posted a quarterly decline for the first time since the first quarter of 2013.
That raised fears that the Korean economy could be entering a deflationary situation like the one Japan had suffered for two decades.
“I don’t think at this stage there is a possibility that the economy would be entering deflation,” Lee said. “But we do need to be on alert. At this point, I believe we are in the same situation as Europe.”
The governor, however, stressed during the press conference that the central bank has no immediate plan to make an additional adjustment of the key interest rate, noting that it will monitor how economic sentiment changes and how the lower rate is influencing consumer behavior.
“There are those who argue that to improve economic sentiment the policy rate should have seen a steeper drop,” Lee said. “But I don’t think lowering the rate is the only factor.”
In a report released after yesterday’s BOK meeting, BNP Paribas concluded that the BOK will likely keep the rate at 2.25 percent for the immediate future.
There have been growing expectations of a further rate cut in the market.
“The governor is undoubtedly under a lot of pressure from the government and the market to lower the policy rate,” said a financial industry official before yesterday’s monetary policy committee meeting. “If he refuses to lower the rate, he will be labeled as failing to communicate with the market like his predecessor, Kim Choong-soo, often was.”
Since he took the post in April, Lee has stressed his desire to enhance communication with the market and minimize any confusion.
“For the policy rate to actually have an impact on the market it needs to be lowered by at least 0.5 percentage point,” the official said. “But this is unlikely as the governor will likely give the impression that the BOK is maintaining its independence and the decision wasn’t made as a result of government pressure. Instead, he is likely to lower the rate later this year.”
The official requested anonymity due to the sensitivity of the issue.
Other analysts made similar predictions before yesterday’s meeting. Chae Hyun-ki, an economist at KTB Investment and Securities, wrote in a report released last week that the BOK would likely lower the rate by 0.25 percentage point.
“Although at this point it is difficult to assess the damage done by the Sewol tragedy and as uncertainties linger, and considering that the GDP is expected to grow 3.8 percent, it is likely the BOK will not lower the rate at a rapid pace,” Chae wrote.
“If the BOK lowers the key rate this month as expected, the market’s interest will be tilted toward an additional rate cut. The BOK may possibly make an additional rate cut basing it on the weak recovery.”
Other analysts have raised concerns over the rate cut’s effect on Korea’s already oversized household debt situation, which could raise the risks of defaults and insolvencies in the financial market.
Last month, Governor Lee said he was more concerned about the household debt problem than he was about a stimulation of the economy by a rate cut, which he at the time said would likely be limited.
When asked about that at yesterday’s press conference, he said: “The possibility of increased household loans resulting from the eased loan-to-value and debt-to-income ratio regulations [on mortgages] played a significant role in our decision on lowering the rate. The rate cut will undoubtedly increase household debt. But looking at the current situation we came to the conclusion that the pace of increase isn’t at a level that we have to be worried about.
“Additionally not only will household debt increase but also the size of incomes will grow,” he continued. “If income grows as much as household debt, we believe it is a situation we wouldn’t have to worry too much.”
BY lee ho-jeong [email@example.com]