Bank of Korea Keeps Rate at Record Low as Risks to Growth Rise

  • Export downturn has worsened and domestic demand is a concern
  • Governor Lee says current rate is still supportive for economy

The Bank of Korea kept its key interest rate unchanged Tuesday for an eighth consecutive month while warning that risks to the economy’s growth path have increased.

The decision to keep the seven-day repurchase rate at a record low 1.5 percent was opposed by board member Ha Sung Keun, who called for a cut, while his five colleagues voted with Governor Lee Ju Yeol. With exports slumping, volatility in financial markets rising and some signs of weakness in domestic demand, the central bank expanded a special loan program for small companies.

South Korea’s government bond yields fell last week after Japan’s adoption of a negative interest-rate policy and the Federal Reserve’s signal that it will delay rate increases. While these events and the uncertain outlook cited by the central bank support the view that the BOK may ease monetary policy further, Lee said Tuesday that current borrowing costs are supportive of the economy.

“Comments in the monetary policy statement were dovish overall, and the board has toned down its assessment of the economy.” said Yoon Yeo Sam, a fixed income analyst for Daewoo Securities Co. “Mentioning the monetary policies of major countries in the statement shows that the central bank feels pressure from external events.”

Market Movement

Korea’s won has weakened 3.6 percent this year versus the dollar, making it the biggest loser among Asian currencies. The yield on three-year government bonds fell 22 basis points during the same period to a record low of 1.44 percent as of 12:27 p.m. Seoul time on Tuesday.

Lee said that while monetary policy is having an effect, the impact of interest-rate cuts is weaker than in the past and monetary policy alone cannot solve structural problems. The BOK will be cautious about changing the key rate, he said, adding that Korea wasn’t at the point of needing to adopt unconventional policies as other countries have.

"Korea also may experience unexpected side effects from a rate cut, as seen in Japan where adopting a minus rate is not working as planned," Lee said.

South Korea’s exports fell 18.5 percent in January, the biggest drop since 2009, as global demand and especially that from neighboring China waned. Consumer prices rose 0.8 percent, the slowest pace since September and far below the central bank’s latest 2 percent target. Other key data for January including industrial production and retail sales will be released later this month or in March.

Export Outlook

With exports expected to remain sluggish, Korea’s policy makers are relying on domestic demand to shore up growth. The finance ministry said it will front-load more fiscal spending to the first quarter.

Still, the measures may be insufficient, and with “fiscal policy ammunition” running out in the second half of the year the government may introduce an extra budget and the central bank will cut rates, economists including Park Chong Hoon at Standard Chartered Plc predicted in a Feb. 12 report.

While the expectation for a rate cut is rising, a possible increase in fund outflows and doubts about the effectiveness of looser monetary policy could limit the BOK’s room to maneuver. Global funds sold $1.4 billion more of Korean bonds than they bought this month through Feb. 15 amid a sell-off in emerging markets. 

Capital Outflows

Lee said Tuesday that capital outflows will persist for some time and that action will be taken to address this if needed.

South Korea is also grappling with rising household debt and the growth of so-called zombie companies that pile up debt stemming from a prolonged period of low borrowing costs.

All 15 economists in a Bloomberg survey forecast the key rate to remain at 1.5 percent Tuesday. Economists at Barclays Plc and Australia & New Zealand Banking Group Ltd. are among those forecasting a cut in March.

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