With the U.S. Federal Reserve (Fed) resuming interest rate cuts after nine months and signaling two additional cuts within the year, the Bank of Korea is expected to speed up its own rate reductions. Analysts say the easing burden from the Korea-U.S. rate gap gives the central bank more room to focus on downside risks to the economy. The odds have also risen that rates could be cut at the Monetary Policy Committee meeting next month.
◇ Fed lowers rates to 4.00%–4.25%… hints at two more cuts within the year
At its regular Federal Open Market Committee (FOMC) meeting held on the 16th–17th (local time), the Fed cut the benchmark rate by 0.25 percentage point (p) to 4.00%–4.25% annually. After cutting rates in September (-0.50%p), November (-0.25%p), and December (-0.25%p) last year, then holding steady for a while, it resumed cuts after nine months. The rate gap with Korea narrowed from 2.00%p to 1.75%p (upper bound basis, Korea 2.50%).
Fed Chair Jerome Powell cited a slowdown in employment as the reason for the cut. Powell said, "As downside risks to employment have increased, the balance (between inflation risks and employment) has shifted," adding, "We judged it appropriate to take another step toward a more neutral policy." The statement released by the Fed also removed the phrase "the labor market is solid" and added that "downside risks to employment have increased."
Indeed, recently released U.S. labor indicators are deteriorating. According to the U.S. Department of Labor on the 5th (local time), nonfarm payrolls last month rose by only 22,000 from the previous month. That was well below the 75,000 forecast compiled by Dow Jones. The unemployment rate rose to 4.3% in August from 4.2% in July.
However, the Fed judged that the current U.S. economic situation is not poor. According to the Summary of Economic Projections (SEP), the Fed presented this year's gross domestic product (GDP) growth outlook at 1.6%, higher than the previous (June) forecast of 1.4%. Next year's growth outlook was also raised to 1.8% from 1.6%. Powell reiterated that concerns about labor market weakness were the main backdrop for the decision to cut the benchmark rate that day, saying, "One could view this decision as a 'risk-management cut.'"
The dot plot (a chart showing the rate outlooks of the 19 FOMC members) released that day suggests two additional cuts within the year are likely. The median year-end policy rate forecast fell 0.3%p to 3.6% this month from 3.9% in June. Assuming the Fed cuts by 0.25%p at a time, that implies about two more cuts. The median rate forecast for the end of next year is 3.4%, 0.2%p lower than the estimated median for the end of this year.
◇ Korea-U.S. rate gap burden eases… focus likely to shift to economic slowdown
Market attention is turning to the Bank of Korea Monetary Policy Committee. The central bank held the base rate at 2.50% at last month's MPC meeting, but Commissioner Shin Seong-hwan submitted a dissent calling for a cut to 2.25%. On the rate outlook, five of the six MPC members argued that the possibility should be kept open of lowering the rate below 2.50% annually within three months, boosting expectations for cuts.
The Fed's decision is expected to add momentum to the Bank of Korea's rate cuts. As the Korea-U.S. rate gap narrowed to 1.75%p, concerns over foreign capital outflows eased. At a press briefing after the MPC meeting held on the 28th of last month, Governor Lee said, "The domestic-foreign rate gap is at a historically high level of 2.0%p," adding, "We will conduct rate policy while viewing the gap as one risk factor."
Heightened downside risks to the economy due to tariff uncertainty are also likely to strengthen the case for cuts. In its currency and credit policy report released on the 11th, the Bank of Korea projected that U.S. tariffs would lower Korea's growth rate by 0.45%p this year and 0.60%p next year, respectively. It expected U.S. tariffs to affect Korea's trade, finance, and overall economic uncertainty, worsening exports and corporations' investment.
However, some expect that with home prices continuing to rise, it will not be easy for the central bank to rush into cuts. According to the Korea Real Estate Board (REB), nationwide apartment prices in the second week of September rose 0.01% from the previous week, turning upward for the first time in 10 weeks since the fifth week of June, right after the June 27 measures were announced. Seoul home prices rose 0.09%, leading the gains, while Gangnam District and Seocho District climbed 0.15% and 0.14%, respectively.
Shinyoung Securities researcher Cho Yong-gu said, "The central bank is likely to cut rates once in the fourth quarter, with the odds slightly higher for a cut in October," adding, "However, the bank still has concerns about the real estate market, and since a rate cut could be a cause of rising home prices, the cut could be pushed back to November."