Quarterly Business Magazine

Bank of Korea Unleashes Surprise Rate Cut as Trade Risks Grow

Posted :
Thursday, July 18, 2019

The Bank of Korea unexpectedly cut its benchmark interest rate as it slashed economic growth and inflation forecasts, joining a growing number of central banks acting to shore up their economies.

The BOK cut the seven-day repurchase rate to 1.5% from 1.75%. It now expects the economy to grow 2.2% this year, versus 2.5% projected in April, and inflation to rise 0.7%, versus 1.1% previously.

With the benchmark rate now only a quarter percentage point above a record low, and financial stability still a concern, BOK Governor Lee Ju-yeol said the central bank still has room to act again -- but not much.

“The BOK will probably take a breather in August,” said Park Chong-hoon, an economist at Standard Chartered Bank in Seoul. “But the very dovish statement from Lee today makes it necessary to stay open to the idea of further cuts in October and November. The worries about the tension with Japan and other data may serve as headwinds for the economy.”

Bonds rallied after the rate cut, with some analysts saying another cut may come by the end of the year. Yields on 10-year and 3-year government bonds slipped to 1.49% and 1.36%, respectively, as of 1:21 p.m. in Seoul.

The BOK’s first rate cut since 2016 reflects urgency among policy makers, who faced growing pressure as the nation’s export-dependent economy slows and other central banks cut rates or signal they will soon.

Regional central banks from Australia to India have cut interest rates this year as global risks worsen. Bank Indonesia is expected to cut its benchmark rate by 25 basis points later Thursday after six hikes last year.

“Bank of Korea’s rate cut reflects a broader policy easing wave across Asia,” said Chua Hak Bin, an economist at Maybank Kim Eng Research Pte in Singapore. “The tide has turned and more rate cuts are coming as growth slows. The U.S.-China trade war is disrupting tech supply chains and Korea is a key node in that chain. Japan’s export controls will worsen the disruption to tech supply chains.”

The U.S.-China trade war, China’s own economic slowdown and a slump in the semiconductor sector have sent Korean exports tumbling for seven straight months. Growing tensions with Japan have further dimmed the outlook.

Lee cited the friction with Japan as one of the factors in the downgraded growth forecast. “If Japan’s export restrictions against South Korea become a reality and even broaden, the impact on our economy, including exports, wouldn’t be small,” he said.

BOK’s Dilemma

The BOK raised rates in November, joining its Asian peers in pushing borrowing costs higher as the Federal Reserve’s rate-hike cycle pressured currencies and drew money out of the region. Eight months later, global monetary policy has shifted course as the trade war has dragged on.

Other factors in that hike were record household debt and elevated property prices. After the policy meeting in late May, Lee stressed that the central bank must consider financial stability as well as economic growth, saying household debt remained “very high” by any measure.

On Thursday, he said the rate cut marked a shift in priority. “The need to support economic recovery has become bigger,” he said.

What Bloomberg’s Economists Say

“Looking forward though, the central bank has limited room for maneuver -- the benchmark rate is now only 25 bps above its record low. That, paired with still-present concerns about financial imbalances, suggests the central bank will exercise extra caution before making any further moves.”

By Sam Kim and Hooyeon Kim

(Bloomberg)

 

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