South Korea's First Interest Rate Cut in 4.5 Years Amid Cooling Real Estate and Slowing Inflation
Following signs of cooling in the domestic real estate market and a significant easing of inflationary pressures, the Bank of Korea has reduced its benchmark interest rate, allowing authorities to ultimately shift their focus to supporting economic activity.
The Bank of Korea lowered the 7-day repurchase rate by 25 basis points to 3.25%, marking the first rate cut in four and a half years, in line with the forecasts of 20 out of 22 economists surveyed. The remaining two economists anticipated that the Bank of Korea would maintain the interest rate at 3.5% to help control housing prices that could stimulate further household debt.
With its policy pivot, the Bank of Korea joins a growing number of central banks worldwide that are easing monetary policy to revive economic momentum as inflationary pressures subside. Last month, the Federal Reserve lowered its key rate by 50 basis points to ensure that a soft economic landing takes precedence over fighting inflation.
Analyst Ahn Yea-ha from Kiwoom Securities Co. stated, "This rate cut is not only a response to sluggish consumption but also indicates that, given the limited pressure to push the inflation rate back above 2%, the Bank of Korea has the capacity to slightly loosen policy." Ahn still predicts that the Bank of Korea will gradually ease monetary policy, maintaining the interest rate unchanged in November.
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Prior to Friday, the Bank of Korea had kept the interest rate at a restrictive level of 3.5% for over a year and a half. Policymakers extended their pattern of inaction in recent months due to concerns that any early signal of a shift could further drive a rebound in the real estate market, threatening financial stability.
The rate cut reflects concerns about stagnant private spending and credit risks related to the construction industry. With most borrowers using floating interest rates, interest expenditures have dragged on consumption, prompting some lawmakers to call for a rate cut by the central bank.
In a report before the interest rate decision, Standard Chartered Bank economists Chong Hoon Park and Nicholas Chia said, "Given the current negative sentiment and the substantial rate cut by the Federal Reserve, the market expects the Bank of Korea to accelerate rate cuts to support economic growth and momentum. Nevertheless, we believe that the negative sentiment towards the Korean economy is exaggerated, and the Bank of Korea may remain cautious about significantly lowering the benchmark interest rate while weighing financial stability risks."
Bloomberg Economics economist Hyosung Kwon said, "Due to the continued rise in Seoul housing prices and debt growth being a major issue, we expect this easing cycle to proceed gradually. Our base case is that the Bank of Korea will keep the interest rate unchanged at the November meeting and then resume rate cuts in the first quarter of 2025."
The Korean government is attempting to control the real estate market by committing to increase housing supply and imposing stricter regulation on mortgage loans, moves that may have convinced the central bank that the market will cool down. A member of the Bank of Korea's board cited these measures before the decision was made on Friday.
Goldman Sachs analysts Goohoon Kwon and Andrew Tilton said in a report, "A moderate easing of monetary policy, in close coordination with financial regulatory authorities, could also help facilitate a soft landing for the real estate market." They predict that, with slowing export growth and other potential economic headwinds, the Bank of Korea may cut interest rates by 25 basis points each quarter until reducing the rate to 2.5% by the third quarter of next year.Factors such as tepid consumer spending, credit risks that undermine construction industry investment, and geopolitical uncertainties will contribute to reinforcing market speculations about another interest rate cut.
After experiencing stronger-than-expected growth in the gross domestic product (GDP) at the beginning of 2024, South Korea's economy unexpectedly contracted in the second quarter. Declining investments dragged down economic activity, while rising borrowing costs and uncertain consumption prospects dampened sentiment. Despite this, policymakers have downplayed the economic slowdown as primarily temporary.
The Korean won has strengthened against the US dollar since mid-August, which may lead South Korean authorities to believe that the won can withstand the impact of an interest rate cut. Despite the appreciation, it remains one of the worst-performing currencies in Asia this year.