BOK flags more rate cuts but in gradual, small steps

South Korea’s central bank is open to more cuts in interest rates after its first rate reduction in more than four years on Friday but only in slow and gradual steps largely due to the country’s still-high household debt.

“From where we stand now, (the policy interest rate) sits above our neutral interest level by any model, so there is room for additional reductions,” Bank of Korea (BOK) Governor Rhee Chang-yong said after the central bank’s rate decision meeting on Friday.

Earlier the day, the BOK lowered its benchmark interest rate by 25 basis points to 3.25%, marking its first rate cut since May 2020 and ending its monetary tightening cycle, which started in August 2021 with a quarter percentage point hike.

The rate reduction was widely anticipated after the country’s inflation moderated toward the central bank’s target of 2% this year. In September, headline inflation stood at 1.6%, well below the target.  

Central banks in the US, UK, European Union and Canada, also moved earlier than the Korean peer to cut their rates amid growing signs of the cooling global economy and slowing inflation, raising expectations that the BOK would soon join them on an easing cycle to shore up the country’s economy.

TIME TO THINK OF ECONOMIC GROWTH 

Korea’s gross domestic product growth slowed in the second quarter at 2.3% after a solid gain in the first quarter. The central bank revised the country’s GDP growth forecast downward to 2.4% for 2024 from its May forecast of 2.5%.

BOK’s rate decision on Friday was made in a 6-to-1 opinion, which could be “interpreted as a hawkish cut,” said Rhee, adding that financial stability will remain a key factor determining the bank’s future rate decision.

He did not offer clear guidance on the central bank's next easing move but said six out of seven board members favor holding rates steady for the next three months, hinting at no rate cut in the bank’s last rate decision meeting next month for this year.

The country’s highly liquid three-year government bond yield retreated 1.5 basis points (bps) to end at 2.947% on Friday, according to the Korea Financial Investment Association. The five- and 10-year debt yields also dipped 1.6 bps to 2.998% and 0.03 bps to 3.085%, respectively.   

STILL CAUTIOUS ABOUT HOUSEHOLD DEBT 

The BOK kept the benchmark interest rate at a 15-year high of 3.50% for 13 straight sessions until August – the longest such run in the country – as the country’s mounting household debt made the bank hesitant to pivot in its monetary policy.

The country’s household debt hit a record high in the second quarter in line with a recovery in the domestic housing market.

The country’s housing market, however, cooled down somewhat with higher borrowing costs from commercial banks in the last few weeks.  

Household loans from the country’s top five commercial lenders – Kookmin, Shinhan, Hana, Woori and NH NongHyup – increased by 5.6 trillion won ($4.2 billion) on-month in September, smaller than a 9.6 trillion won gain the previous month.

But household debt remains a concern, said the BOK chief.

“Household debt contracted in September but it is still early to confirm financial stability,” said Rhee. “The bank will monitor how the rate cut would affect housing transactions and the rising pace of housing prices.”

Rhee said Korea is not in the same position as the US, which can make a big cut of half a percentage point.

“The US hiked the base rate by over 5 percentage points to tame the country’s high inflation of a more than a 10% jump, which justifies the Fed’s fast-paced cutting,” said Rhee.

“But we raised our rate by 3%, meaning it is wrong to expect a 0.5 percentage point cut like the US and think to borrow money too easily.”

After the rate cut, the Bank of Korea hinted at a slow easing cycle, citing lingering economic uncertainties.

“The moderate growth trend will continue, but uncertainties regarding the future path of output growth have heightened,” said the bank.

Write to Jin-gyu Kang and Eui-Jin Jeong at josep@hankyung.com

Sookyung Seo edited this article.