BOK Cuts Rate for 1st Time Since May 2013 to Boost Growth

South Korea’s central bank cut its interest rate for the first time in more than a year, risking inflaming record household debt as it backs government efforts to spur Asia’s fourth-biggest economy.

Governor Lee Ju Yeol and his board lowered the seven-day repurchase rate to 2.25 percent from 2.5 percent, the Bank of Korea said in a statement in Seoul today. Fourteen of 18 economists surveyed by Bloomberg News forecast the move, with the rest seeing no change.

President Park Geun Hye last month announced 11.7 trillion won ($11.3 billion) in stimulus and measures to spur a stagnant property market and boost growth that slowed last quarter to the weakest in more than a year. While inflation below the central bank’s target offers room to act, lower borrowing costs could encourage households to add to debt that was 135 percent of disposable income at the end of 2013.

“Policy makers are pumping up the economy through all possible means,” Daewoo Securities Co. fixed-income analyst Yoon Yeo Sam said in Seoul after the decision. “The ball is now in the court of consumers and businesses. If they don’t respond as much as expected, the government and central bank may have to take more action.”

Today’s cut, which brings the rate to the lowest since 2010, was opposed by one board member, who said policy should be left unchanged, Governor Lee said at a briefing. The move is aimed at preventing weak sentiment from harming growth and was possible because pressure from inflation isn’t high, he said. Lee declined to say if the board discussed a deeper cut.

Independent Decision

The yield on South Korea’s three-year government debt rose three basis points, or 0.03 percentage point, to 2.55 percent as of 2:19 p.m. in Seoul, Korea Exchange Inc. prices show. The five-year yield increased two basis points to 2.77 percent.

The won gained 0.6 percent to 1022.85 per dollar. The Kospi index of shares fell 0.2 percent.

The central bank last month cut its growth forecast for this year to 3.8 percent, citing weaker-than-expected domestic demand after a deadly ferry disaster in April, which prompted consumers and businesses to cut spending in mourning. The economy’s expansion slowed to 0.6 percent in the second quarter from three months earlier.

The BOK faced political pressure ahead of today’s meeting to ease policy. Kim Moo Sung, leader of the ruling Saenuri Party, last month called for consideration of preemptive steps such as lower borrowing costs to boost domestic demand.

Household Debt

“The action taken will create synergy with the government’s policies, helping to improve weakened sentiment and maintain the economic recovery,” Governor Lee said after the decision. “The decision to cut the rate today was an independent one,” Lee said, adding that political pressure on the central bank wasn’t desirable.

Today’s reduction follows the central bank’s decision last month to expand a lending program for smaller firms by 3 trillion won. It announced the move on the same day Finance Minister Choi Kyung Hwan unveiled the fiscal package and other measures aimed at boosting credit and encouraging companies to distribute more of their profits in wages and dividends, and pledged an expansionary budget next year.

Lower borrowing costs, combined with looser rules for home mortgages, may accelerate the growth of household debt, which rose to record 1,024.8 trillion won at the end of March. The government plans to boost household income and create more jobs to address the debt issue, according to Choi.

Rate Outlook

Downside risks to inflation were bigger than upside risks, the central bank said in a report on July 31, after saying earlier in the month that inflation pressures were weaker than previously expected.

The BOK may cut its interest rate further this year, said Lee Jaewoo, chief Korea economist at Bank of America Corp.’s Merrill Lynch unit in Seoul.

“While sentiment can improve on government measures, it will take some time to see actual increases in economic data like consumption or inflation,” he said.

Gareth Leather, an economist at Capital Economics, said the move today is unlikely the start of a prolonged period of policy-easing.

“With growth likely to bounce back strongly in the second half of the year on increased government spending and faster exports, we wouldn’t be surprised to see today’s cut reversed early next year,” Leather wrote in a note after the decision.

Governor Lee said in April and May inflation was expected to pick up into BOK’s target range of 2.5 percent to 3.5 percent, and that the central bank could consider lifting its interest rate when demand started to drive consumer price pressures.

The BOK’s decision last month to keep the rate unchanged was the first time since May 2013 a vote wasn’t unanimous. Chung Hae Bang opposed the other six board members and called for a rate cut, citing uncertainty over the economic outlook and concerns that consumer and business sentiment may stay weak “for a long time,” according to minutes of the meeting.

An unnamed board member said the BOK should manage policy to help an economic recovery and prevent sentiment from falling into a “low expectation trap,” the minutes showed.

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