Decision-Day Guide: Bank of Korea Seen on Hold Before Fed Meets

  • With no change expected in rate, all eyes on policy statement
  • Economists seeking clues from Lee on growth, inflation trends

The Bank of Korea is widely forecast to maintain its record-low key interest rate Thursday as board members await the Federal Reserve’s policy decision.

South Korea’s third-quarter growth picture -- which was stronger than expected and also showed a pickup in inflation -- is bolstering the view that the BOK will keep its benchmark seven-day repurchase rate at 1.5 percent.

At least four of seven board members have said the economy is moving in line with the central bank’s October forecast, although possible risks to growth are China’s slowdown and the Fed’s expected decision to raise rates, minutes from the Nov. 12 BOK board meeting show. The Federal Open Markets Committee is scheduled to meet on Dec. 15-16.

The BOK’s rate decision will be announced about 10 a.m. in Seoul, followed by a monetary policy statement. Governor Lee Ju Yeol’s press briefing usually starts at 11:20 a.m. With all 17 analysts surveyed by Bloomberg projecting no change in the key rate, the market’s focus will be on any revisions to the statement. Attention also will focus on Lee’s views on the economy and the impact of a Fed rate increase. Below are key points to watch:

2016 Outlook

The BOK expects next year’s growth will be 3.2 percent, an improvement in the 2.7 percent growth rate it’s projecting for 2015. Not all economists agree, with seven surveyed about longer-term prospects forecasting another rate cut in the first six months of 2016. Thirteen predicted that the main interest rate would remain at 1.5 percent, while three forecast an increase to 1.75 percent.

Key to South Korea’s economic growth outlook is whether the current recovery -- which is being led by domestic demand -- can be sustained. Exports stripped 0.8 percentage points from the 1.3 percent growth rate in the third quarter, while domestic demand added 2 percentage points, central bank data show.

Citigroup Inc. said in a report this month that South Korea’s gains in domestic demand are mostly driven by government policies including temporary consumption tax cuts. With exports posting back-to-back declines in October and November, Citigroup forecasts economic growth will slow to 0.4 percent in the fourth quarter. 

Challenges to domestic demand also include tighter lending rules to be applied from next year, which may hurt property markets and affect consumption. The BOK is scheduled to release an updated economic outlook in January; Governor Lee may provide signals if major revisions are expected.

Fed Decision

The widely anticipated Fed rate increase this month poses a dilemma for the BOK. With the won strengthening against the euro and the yen, it puts pressure on the board for additional monetary easing, while at the same time the Fed’s rate increase would raise South Korea’s capital outflow risks from emerging markets.

The nation’s policy makers are of the view that with sufficient foreign-exchange reserves and a current-account surplus, any shocks to South Korea’s economy from capital outflow upon the Fed’s move will be limited. Still, officials are wary of excessive moves in the exchange rate and may step up verbal or other intervention following the U.S. rate decision.

South Korea’s three-year government debt yield rose 20 basis points since the end of September while the yield for 10-year bonds rose 16 basis points, tightening financial market conditions even with the benchmark rate at a record low. Governor Lee may hint at options available to the central bank if the bond market becomes less stable upon the Fed’s action.

Monetary Policy Statement

The BOK said in the November policy statement that economic sentiment has improved “somewhat,” a change from October when the board said improvement in sentiment has been “inadequate.” The board held the view that Korea’s economy will continue its recovery, although uncertainties surrounding the growth path remain high. Another upbeat assessment of the economy would further erode expectations for an additional rate cut.

BOK’s Lee also may refer to progress in setting the new inflation target range to be applied from 2016, which the central bank needs to announce by the end of the year. Lee said at a November press briefing that discussions were continuing with the government.