The Bank of Korea's Monetary Policy Committee has resumed the trend of lowering the base rate to 2.75% per year. This marks the reopening of the 2% era of the base rate that ended in October 2022, when the Bank of Korea raised the rate from 2.75% to 3.0%. It appears that increased downward risks to the economy amid ongoing political instability following the emergency state are the reasons for the rate cut.
The Bank of Korea's Monetary Policy Committee (hereafter referred to as the Monetary Policy Committee) lowered the base rate by 0.25 percentage points to 2.75% during its regular meeting held on the 25th. After consecutively lowering the rate from 3.5% to 3.0% in October and November of last year, the Monetary Policy Committee had frozen the rate last month, taking a breather. However, it has resumed the rate cut this time.
In the monetary policy direction resolution, the Monetary Policy Committee stated, "While there are still concerns in the foreign exchange market, it is deemed appropriate to further lower the base rate to ease downward pressure on the economy, as the inflation rate remains stable and the trend of household debt has been slowing down, while significant declines in growth rates are expected." They added, "While monitoring growth trends, we will ensure that the inflation rate stabilizes at the target level over the medium term and manage monetary policy with care for financial stability."
Ahead of the Monetary Policy Committee meeting, there was an expectation of a base rate cut in the market, although the possibility of freezing was also raised. According to a survey conducted by the Korea Financial Investment Association from the 12th to the 17th, 55% of 100 bond management personnel expect the Bank of Korea to lower the base rate at the February Monetary Policy Committee meeting. Meanwhile, 45% anticipate a freeze.
Experts predicting a rate cut noted that consumer sentiment has contracted due to the state of emergency and the impeachment crisis, leading to a slowdown in economic growth. The Bank of Korea forecasted last month that this year's growth rate would be lower than the previous estimate of 1.9%, falling between 1.6% and 1.7%. On the 18th, Governor Lee Chang-yong mentioned in the National Assembly that they were "also considering a growth rate forecast of 1.6%," increasing the likelihood of further downward adjustments.
At last month's Monetary Policy Committee meeting, all six members, except the governor, emphasized the need to keep the possibility of rate cuts open within three months, which heightened expectations for a rate cut. The committee members judged that it would be prudent to respond to the economy through a rate cut after verifying the changes in domestic political uncertainty and external economic conditions, as the domestic economy was not performing as well as expected.
However, the high level of the won-dollar exchange rate raises uncertainty about whether the rate cut trend will continue at the next Monetary Policy Committee meeting. The exchange rate exceeded the 1486 won level shortly after the impeachment of Prime Minister Han Duck-soo, reaching the highest level since March 16, 2009 (1488.5 won) during the financial crisis. Following some alleviation of political instability due to the appointment of constitutional judges, the rate has fallen to the 1420 won range but remains above 1400 won.
The weakening expectations of rate cuts by the Federal Reserve (Fed) due to the tariff policies of the Trump administration, which have pushed up inflation in the United States, also contribute to the higher likelihood of a freeze. According to the Chicago Mercantile Exchange Group's FedWatch, market participants anticipate a 95.5% chance that the federal funds rate will be held steady at 4.25% to 4.5% at the March Federal Open Market Committee (FOMC) meeting. This probability has increased by 23.1 percentage points compared to a month ago (72.4%).
Jo Yong-gu, a researcher at Shinyoung Securities, noted, "Considering the execution of the supplementary budget in the second quarter and the potential for economic improvement in the second half, as well as the inflation rate at the target level (2.0%) and concerns regarding the depreciation of the won, I expect a gradual rate cut rather than a sharp one." He also mentioned, "Governor Lee Chang-yong has directly expressed the risks of rising asset prices and the burden of currency depreciation as side effects of the rate cut."
Meanwhile, the Monetary Policy Committee decided to lower the interest rate of the financial intermediary support loan from 1.50% to 1.25% per year, effective from today. The financial intermediary support loan is a system through which the Bank of Korea supplies funds at low interest rates to increase loans from commercial banks to small and medium-sized enterprises.