The factors pushing the BOK to hold rates steady

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The factors pushing the BOK to hold rates steady

The decision by the Bank of Korea (BOK) yesterday to maintain the benchmark interest rate at 3 percent was a desperate measure under challenging circumstances. With both domestic consumption and exports — twin engines of the Korean economy — faltering, the nation now faces the shock of annual growth at less than 2 percent. It seemed an opportune time to lower rates and stimulate the economy. However, the simultaneous emergence of Donald Trump’s presidency and the compounded chaos of martial law and impeachment has led to heightened currency instability, forcing the central bank to hold rates steady.
 
Currency volatility has become an immediate concern. The won-dollar exchange rate recently surpassed the crisis-level threshold of 1,450 won per U.S. dollar and appears poised to breach 1,500. A persistently weak won risks driving up import prices, stoking inflation and creating further headwinds for investment and employment. The BOK could not afford to overlook these risks.
 
The labor market has also taken a hit. In December, the number of employed individuals fell by 52,000 compared to the previous year, marking the first decline in 46 months. The annual increase in employment last year was halved to just 160,000 compared to the year prior. Despite this grim scenario, the central bank opted for a rate freeze due to developments in the U.S. economy.
 
Donald Trump’s incoming administration has pledged sweeping tariff increases, including a general 10 percent duty, along with corporate tax cuts. These policies are expected to elevate U.S. import prices and inflate fiscal deficits, driving up market interest rates. Indeed, yields on 10-year U.S. Treasury bonds, which had fallen to 3.6 percent last September, have surged to 4.8 percent since Trump’s election. This has led to speculation that the U.S. Federal Reserve might end its anticipated cycle of rate cuts and instead pivot toward hikes, as noted by Bank of America.
 
Amid these uncertainties, the role of fiscal policy has never been more critical. The Korean government’s budget for this year, diminished after partisan wrangling, will likely require a supplementary budget to address economic strains. However, since 75 percent of the total budget is slated for front-loaded spending in the first half, the effectiveness of additional fiscal measures must be carefully assessed.
 
Particularly contentious is the Democratic Party’s push for regional currency legislation, seen as an election-oriented populist measure that raises doubts about fiscal efficiency. Should a supplementary budget be inevitable, a clear road map for timing and scale is essential. BOK Gov. Rhee Chang-yong has recommended a swift supplementary budget of 15 trillion won ($10 billion) to 20 trillion won, emphasizing targeted support for small business owners over blanket cash handouts.
 
Victor Cha, a senior fellow at the Center for Strategic and International Studies (CSIS), cautioned yesterday in a blog post that “while the Korean government expresses confidence in the resilience of its economy, prolonged political instability poses greater risks.” This warning should not fall on deaf ears. To rescue the fragile Korean economy, bipartisan cooperation is critical. Before resorting to supplementary budgets, lawmakers must prioritize passing urgent legislation such as the Special Semiconductor Act, which aims to boost corporate investment and address livelihood issues.
 
Translated using generative AI and edited by Korea JoongAng Daily staff. 
 
 
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