N. Korea Threats Boost First BOK Rate Cut Odds Since October

North Korea’s threats are raising the odds of the first interest-rate cut by its southern neighbor since October as they threaten to damp business and consumer sentiment in Asia’s fourth-largest economy.

Warnings of missile strikes and nuclear tests by Kim Jong Un’s regime have helped send South Korea’s main stock-market index down 4.2 percent this month while the won has declined 2.5 percent against the dollar. Eleven of 20 economists forecast the Bank of Korea will reduce borrowing costs tomorrow, according to a Bloomberg News survey.

The war threats weigh on central bank Governor Kim Choong Soo as new President Park Geun Hye’s government pressures him to lower borrowing costs and Japan embarks on record easing that may weaken South Korean export gains. Bond yields are also signaling a rate reduction and have fallen to record lows after the Finance Ministry cut its 2013 forecast for economic growth.

“The central bank may come forward with more aggressive action before investors and consumers lose confidence,” said Lee Jae Hyung, a fixed-income analyst at Tongyang Securities Inc. in Seoul. “Geopolitical tension” is adding to pressure on the Bank of Korea from the government for an interest-rate cut as the won and stocks slide, Lee said.

The Bank of Korea’s decision is due tomorrow at 10 a.m. in Seoul. A quarter percentage-point reduction would be the third such cut in nine months and bring the benchmark seven-day repurchase rate to 2.5 percent, the lowest level since January 2011.

Crisis Atmosphere

North Korea’s effect on financial markets is getting more intense, the South’s Finance Ministry said in a statement today. It said it will submit a stimulus proposal to lawmakers next week in hopes of getting their approval by the end of the month. The extra money will be used to ensure price stability, promote startups and support the property market, it said. The size of the supplementary budget hasn’t been set yet, it said.

The threats by Kim Jong Un’s regime to carry out nuclear strikes against the U.S. and South Korea have fueled a crisis atmosphere in the region and prompted calls for dialogue. The South Korean government said North Korea may be ready to conduct a nuclear test or missile launch as early as this week. Yesterday, North Korea warned all foreigners in South Korea to prepare evacuation plans in case of war.

Industrial Complex

North Koreans employed at the joint Korean industrial complex in the border city of Gaeseong didn’t report for work yesterday, severing the last exchange link between the two countries. South Korean companies employ more than 53,000 North Korean workers at Gaeseong.

The yield on the benchmark three-year government bond traded at 2.49 percent yesterday, down 17 basis points from a month ago, according to Korea Financial Investment Association data. The yield, which touched a record low of 2.44 percent on April 5, has traded below the 2.75 percent policy rate since Feb. 5. The Finance Ministry on March 28 lowered its 2013 economic-expansion forecast to 2.3 percent from December’s 3 percent, below the central bank’s 2.8 percent projection.

“The bond market has already priced in a 0.25 percentage point cut,” said Lee Jae Seung, a fixed-income analyst at KB Investment & Securities Co. in Seoul. “The escalating threats from North Korea and their actions over Gaeseong are helping to justify a BOK rate-cut decision.”

Central Bankers

South Korea’s political leadership has put pressure on central bankers ahead of tomorrow’s announcement. Cho Won Dong, chief economic adviser to Park, said last week that “it will be better” if the Bank of Korea lowers interest rates given that the government may need to issue bonds. Lee Hahn Koo, floor leader of the ruling New Frontier Party, on April 1 urged the central bank to consider stimulus measures such as a rate cut.

Nomura Holdings Inc. sees a 45 percent chance that the Bank of Korea “succumbs to political pressure and cuts rates,” Kwon Young Sun, a Hong Kong-based economist, said in an April 8 report, raising his previous estimate of a 40 percent probability. “This would imply that the government now has de facto control over monetary policy and therefore further rate cuts would be possible.”

South Korea’s government plans this month to unveil fiscal stimulus, including an extra budget, to boost the economy. The Finance Ministry in a report yesterday cited geopolitical risks related to North Korea as growth concerns in addition to Europe’s debt crisis. The ministry also said consumption and investment remain weak.

Inaugural Speech

Finance Minister Hyun Oh Seok in his March 22 inaugural speech vowed to use “all possible policy measures” to boost an economy that’s grown less than 1 percent from quarter to quarter for seven periods. A weakening yen is a “problem” that is flashing a red light for exports, Hyun said March 23.

The economy expanded 2 percent last year, the least since the global financial crisis, compared with a potential-growth rate of 3.8 percent estimated by Kim, the central bank governor. Consumer inflation has remained below the Bank of Korea’s target range of 2.5 percent to 3.5 percent so far this year, with prices rising 1.3 percent in March from a year earlier, the slowest rate in seven months.