Korea: Bank of Korea holds fire in a bid to bolster a languishing economy
April 13, 2017
At its 13 April meeting, the Bank of Korea (BoK) announced its unanimous decision to maintain the base rate unchanged at an all-time low of 1.25%, in line with market expectations. Although the BoK also reaffirmed its monetary easing stance to further buttress the country’s economy, officials barely have any room left to maneuver as the U.S. Federal Reserve hikes rates and domestic household debt balloons. The BoK had lowered interest rates by 25 basis points in June 2016 in what it had described as a preemptive move and has since refrained from making further changes to the main policy rates.
The Bank’s decision came as policy makers revised the country’s economic outlook slightly upwards. According to the BoK, the economy has recently benefited from improved dynamics in Korea’s exporting sectors and a pick-up in investment. Both of these are mostly related to the cyclical upturn in the all-important electronics sector. Conversely, household consumption remains weak, with downbeat sentiment driven by mounting geopolitical tensions and a feeble labor market, coupled with a high level of indebtedness, weighing on private spending. Regarding prices, inflation hovered over the 2.0% target level in March for the first time in five years. Although this is likely to sway officials from cutting rates anytime soon, the statement did note that demand-driven inflationary pressures are meagre and likely to drag on the headline figure, with inflation for the whole of 2017 revised only slightly upwards to 1.8% (January report: +1.7%).
The statement did provide conclusive evidence that the Bank is likely to stay put for the time being. The monetary easing stance is aimed at supporting growth at a time of growing uncertainties in global trade policies and regional geopolitical risks. The truth is, however, that alternatives are in short supply. Household debt, which reached a record-breaking high by the end of 2016, is gradually becoming the Bank’s chief concern. A further easing in interest rates, although with potential to boost the economy, would prompt households to expand their debt levels, further adding to the risk. Conversely, a hike in interest rates would increase consumers’ debt burden, hampering their willingness and ability to spend, and would also reduce investment.
Another important caveat is the U.S. interest rate normalization cycle. Traditionally, interest rate hikes by the U.S. Federal Reserve are followed by rate increases in Korea to prevent an outflow of foreign capital looking for more profitable, less risky assets in the U.S. Aiming for a rate cut instead of a rate hike would lay the ground for just such an event, which would put the Korean economy at the crossroads. The Bank’s governor, however, noted at the follow-up press conference that the need for further rate cuts had lessened to some extent, thus limiting the probability of a further cut.
Consensus is growing among analysts that the Bank will stay on hold until the conditions are ripe for officials to hike interest rates. Young Sun Kwon, Senior Economist at Nomura, comments on which scenarios could accelerate the taking of such a decision:
“We see a risk of the BOK hiking rates this year […] if: 1) a recovery in Korean exports more than offsets weaker consumption; 2) USD/KRW surges due to sudden, massive capital outflows from emerging markets; 3) the Fed moves towards a much steeper hiking cycle (more than three hikes); or 4) Korea’s household debt growth accelerates despite tighter measures on mortgage loans.”
Author: David Ampudia, Economist