Photographer: Jeon Heon-Kyun/EPA

Bank of Korea Holds Rate at Record Low; Cuts GDP Forecast

  • Central bank now projects growth of 2.5 percent this year
  • Some economists see further rate cuts ahead as growth slows

South Korea’s central bank left its key interest rate unchanged for a seventh month on Friday, even as it cited a weakening recovery in cutting its 2017 growth forecast.

The Bank of Korea said exports are likely to continue improving, thanks to a strengthening global economic recovery, but noted deteriorating sentiment at home and slowing economic growth in the fourth quarter of last year. It cut its forecast for gross domestic product this year to an expansion of 2.5 percent, from 2.8 percent projected in October.

Governor Lee Ju-yeol said weakening consumption was the primary reason for cutting the growth forecast, and cited political uncertainty following the impeachment of President Park Geun-hye as the reason for plummeting confidence. The central bank kept the seven-day repurchase rate at a record-low 1.25 percent, a decision that was unanimous and expected by all 21 economists surveyed by Bloomberg.

"South Korea’s exports-driven economy, seen as a bellwether for global trade, was hit hard by a slowdown in China last year," said Stephen Innes, Singapore-based senior trader at foreign-exchange company Oanda. "But with signs China’s economy is improving and global inflation is rising, there was less incentive for the BOK to cut rates."

Outlook

Consumer sentiment in South Korea plunged in December to the lowest level in more than seven years amid a political scandal that led to Park’s impeachment. Risks to the outlook include rising household debt, further political turmoil and possible threats to global trade. 

Faced with slowing growth and multiple headwinds, it is only a matter of time before the BOK cuts rates again, according to Capital Economics, which sees one cut of 25 basis points this year.

"While we expect the BOK to cut its policy rate again this year, it is likely to proceed cautiously amid concerns that further rate cuts would encourage Korea’s debt-laden households to increase their borrowing even further," Asia economist Krystal Tan said in a note after the decision. "The BOK will also keep one eye on the U.S. Fed. The central bank is concerned that cutting interest rates at a time when the Fed is in the middle of a tightening cycle could lead to disruptive capital outflows."

Lee said policy would remain accommodative and the central bank wouldn’t adjust rates based on the number of Fed increases.

The central bank decided to hold rates steady because growth is expected to improve in the second half of the year, said Lee. He cited concerns about financial stability and said the central bank will closely monitor household debt and potential changes in U.S. monetary policy.

The BOK also trimmed its inflation forecast for the year to 1.8 percent from 1.9 percent, saying prices would gradually rise to near its 2 percent target by mid-year. The government in December said it expects inflation of 1.6 percent and growth of 2.6 percent.

"The extent of the economic growth downgrade was bigger than expected, but the central bank didn’t give signals that it intends to change monetary policy,” said Park Jong-youn, a fixed-income analyst at NH Investment & Securities in Seoul.

Debt Burden

Household debt, which hit a record 1,296 trillion won ($1.1 trillion) as of end-September, is expected to limit the central bank’s options on rates. While policy makers have said the amount of debt doesn’t pose an immediate risk to the financial system, they have expressed concerns that rising bond yields at home, in line with a global move, may increase default risks for low-income debtors.

The central bank will seek to prevent excessive foreign-exchange volatility, Lee said, citing liquidity as one reason for the recent volatility. He said the won’s exchange rate had been more volatile than those of other currencies.

The won appreciated 0.6 percent on Friday to 1,178.18 per dollar as of 12:12 p.m. in Seoul. The yield on five-year government bond rose four basis points to 1.83 percent, Korea Exchange prices show.

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