Korea leaves rates and passes forex buck to incoming government

As expected, the Bank of Korea left its policy interest rate unchanged at 2.75 per cent a year on Thursday, citing the country’s gradual economic recovery, even though South Korean exporters are battling strong headwinds from the weaker Japanese yen.

There had been expectations that the central bank might cut rates to boost economic growth and help curb the won’s appreciation against the dollar and the yen. But Kim Choong-soo, BoK governor, said interest rates were already accommodative and, in any event, there was no clear relationship between interest rates and exchange rates in Korea.

Kim reiterated his belief that the Korean economy is over the worst, sparking speculation that the BoK’s easing cycle may be over. The central bank held interest rates steady for a fourth straight month after cutting them by 25 basis points in July and October, as the export-driven economy is believed to have bottomed in the third quarter.

However, Kim cautioned that Japan’s expansionary monetary policy could affect South Korea’s future growth as a weaker yen could hurt Korean exporters’ competitiveness. The won has gained 5.6 per cent against the yen so far this year after advancing 22.8 per cent last year, raising concerns about the country’s export outlook. South Korea’s exports posted double-digit growth in January but automakers Hyundai Motor and Kia Motors have forecast their weakest sales growth for a decade this year, with the stronger won expected to squeeze their margins.

“We do not believe the BoK will cut rates on forex considerations alone. This is because the impact of a further rate cut will unlikely curb the Korean won’s appreciation,” says Ronald Man, economist at HSBC, noting that interest rates are much higher than the ultra-low interest rates of the US, Europe and Japan. “Furthermore, with the worst likely behind Korea, the central bank will remain cautious in delivering too much easing, which can reignite inflationary pressures and fuel household debt down the road.”

Many economists expect Korean policymakers to respond to the stronger won through foreign exchange intervention or capital controls rather than through monetary policy. Seoul has already strengthened regulations on forex derivatives positions held by banks operating in the country to curb capital flows into Asia’s fourth-largest economy.

Some economists say the BoK could leave the job of shoring up the economy to the next government, which is widely expected to expand fiscal spending to boost welfare. Kim’s recent emphasis on coordination between monetary and fiscal policies has fueled such speculation, with the BoK’s Thursday meeting being the last before president-elect Park Geun-hye takes office on February 25.

“We believe today’s decision also reflects the incoming administration’s preference to stimulate the economy using faster-acting fiscal tools from here, rather than monetary policy,” says Wai Ho Leong at Barclays.

Still, economists are not sure about the BoK’s future policy direction, given many uncertainties over the global economy. “[President-elect Park] has come out strongly in support of over-indebted households,” RBS economist Erik Lueth said in a report. “A rate cut would be a straightforward way to ease their plight.” Lueth expects a cut as early as March.

Related reading:
Foreigners flee South Korea, beyondbrics
Seoul rattles sabre in currency war, beyondbrics
Wary Korean consumers reflect broader ills, FT