South Korea’s central bank cut interest rates for the first time in five months yesterday in a surprise move, joining the ranks of other economies which have recently taken advantage of lower inflation to ease monetary policy to spur sluggish growth. The Bank of Korea’s monetary policy committee, grappling with a weaker-than-expected economic recovery, lowered its base rate by 25 basis points to a record low of 1.75%, confounding expectations that it would wait at least another month to see if domestic and export demand improved.
The committee split in a 5-2 vote, Governor Lee Ju-yeol said, without elaborating on the arguments of the dissenters. A snap poll conducted by Reuters soon after the decision showed most analysts do not see another rate cut this year. Bond futures initially rose and the won fell to a 20-month low after the decision, but bonds later returned to previous levels and the won recouped losses as traders took profits from the dollar’s recent rally after the central bank move.
“It (the rate cut) came one month earlier than we had expected,” said Lim Ji-won, economist at JPMorgan Chase & Co in Seoul. “An additional cut still remains a possibility if the growth situation does not improve much from here, but at this point it really depends on the data.”
Governor Lee said the cut – the first since October and the sixth since the BOK’s easing cycle started in July 2012 – was a pre-emptive move to keep the weak momentum seen in the first two months of the year from hurting the economy’s growth potential.
“We saw that the economy was not growing as much as thought and that inflation would be lower than expected,” Lee said. “We decided it would be better to act pre-emptively as we confirmed the risks were there.”
But Lee was cautious about further rate moves.
“The Bank of Korea is making preparations based on the scenario that the Federal Reserve will start raising rates in the second half of the year. However, we don’t feel that we will have to hike rates right away when the US begins tightening.”
The market’s consensus view had been that the central bank would lower the rate when it revises growth forecasts in April.
Front-month futures on three-year treasury bonds were at 108.93 at 0616 GMT, up just 0.02 points and far below a session high of 109.19. The won finished domestic trade flat at 1,126.4 against the dollar after having fallen as much as 0.9%. The Bank of Korea cut its growth forecast for this year to 3.4% in January from the previous 3.9% and is widely expected to lower it again next month as China’s growth continues to cool and much of Europe flounders.
South Korea’s industrial production plunged in January and annual inflation slowed to a 16-year low in February, though officials blamed much of the low price growth on falling commodity prices rather than weak consumption. Exports suffered their worst fall in two years in February, but policymakers say overall global demand has shown some signs of gradual recovery.
Economists have said South Korea’s heavy and growing household debt was one of the main constraints on the central bank’s policies. The average household carries debt amounting to some 160% of disposable annual income, higher than that of US households before the subprime mortgage crisis which sparked the 2008 global meltdown. Governor Lee said foreign exchange rates were important to South Korean exporters but disagreed with some analysts’ views that the current global easing trend was aimed primarily at depressing exchange rates. Rather, he said, the policy changes were sparked by economic problems in their respective countries.
The Bank of Thailand also cut its policy interest rate on Wednesday in a surprise move. India has cut rates twice already so far this year and China has eased policy two times, with more moves expected. Singapore, Australia and Indonesia have also eased.