Bank of Korea Holds Key Rate at Record Low Before Fed Meets

  • Better-than-expected third-quarter growth reduced pressure
  • Oil price drop adds downside risk to 2016 Inflation outlook

The Bank of Korea left its benchmark rate unchanged for a sixth consecutive month Thursday as board members opted to wait for the Federal Reserve’s anticipated rate increase and assess its effects on the global economy and markets.

The decision to keep the seven-day repurchase rate at 1.5 percent was forecast by all 17 economists in a Bloomberg survey. Earlier this month, data showed South Korea’s third-quarter growth was better than estimated, while inflation rose at the fastest pace this year.

While South Korea’s domestic economy has sustained a recovery trend led by consumption, improvement in sentiment has been inadequate amid declining exports, the BOK said in statements after the rate decision. A slowdown in the global economy and a drop in oil prices add uncertainty to the BOK’s 2016 economic outlook, Governor Lee Ju Yeol said in a press briefing.

Indirect Signal

Governor Lee “indirectly signaled the central bank may revise down its 2016 outlook next month by mentioning a delay in the global economic recovery and a drop in oil prices,” said Yoon Yeo Sam, a Seoul-based fixed-income analyst for Daewoo Securities Co. “Rate-cut expectations may resurface if the BOK lowers the growth outlook next year.”

The central bank said in October that it expects 3.2 percent economic growth and 1.7 percent inflation next year.

South Korea’s government bond yields rose this quarter as expectations for an imminent rate cut faded. Several BOK board members said at the Nov. 12 rate policy meeting that recent economic data is in line with the central bank’s projections, although a slowdown in China and declining exports pose risks.

The yield on Korea’s three-year government bonds rose 21 basis points since the end of September to 1.78 percent as of 12:28 p.m. in Seoul on Thursday. The won weakened about 1.7 percent against the U.S. dollar in the past month.

The Federal Open Market Committee will hold its last meeting of the year on Dec. 15-16 and is widely expected to raise the U.S. benchmark federal funds rate, which has been held near zero since late 2008.

U.S. Rate Decision

Of concern to South Korea’s policy makers upon an anticipated U.S. rate increase is potential capital outflow from emerging markets, which could cause financial market uncertainty and exacerbate slowdown concerns. 

Governor Lee said Thursday that because the Fed is expected to make gradual rate increases and Korea has a large current-account surplus, the nation will see limited capital outflow. Still, the rate change could add uncertainty to some fragile emerging economies and may develop into a crisis, Lee said. Lee added that the BOK doesn’t have to follow by raising its interest rate immediately after the Fed’s decision.

Economic Growth

Korea’s gross domestic product expanded 1.3 percent in the third quarter from the previous three months, the biggest gain since 2010 and higher than the initial estimate for 1.2 percent, the central bank said this month. Exports stripped 0.8 percentage points from the gain, while domestic demand added two percentage points, the data showed. 

Korea’s growth momentum will weaken in 2016 as government support for domestic consumption fades and exports remain weak, Standard Chartered Bank economists including Park Chong Hoon wrote in a Dec. 3 report. Recent sales events promoted by the government may have exhausted household spending capacity and rising household debt could halt a consumption recovery, the report said.

Sluggishness in exports is one reason some economists continue to expect an additional rate cut by the BOK next year to aid corporate activities and exchange-rate competitiveness. Still, a majority hold the view that the benchmark rate will be unchanged for the foreseeable future with economic growth strengthening and household debt rising to a record level, reaching 1,166.04 trillion won as of the end of September.

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