Bank of Korea throws interest rate curveball

12th July 2012

The cut by 25 basis points from 3.25% to 3.00%  marks a shift by the central bank to prioritize growth now that inflation in Asia's fourth largest economy is at a 32-month low. Its corresponding assessment of the global and domestic growth outlook was particularly grim and comes after the Korea International Trade Association (KITA) said exports will grow by 2.4 percent this year after expanding by 19 percent in 2011.

"The Committee considers some economic indicators in the US to have shown signs of deteriorating, and the sluggishness of economic activities in the euro area to have deepened," the minutes said. "Growth in emerging market countries as well has continued to slow, mostly on sluggish exports. Going forward the Committee expects the pace of global economic recovery to be more moderate than originally forecast, and judges the downside risks to growth to be intensifying further."

The rate cut in South Korea is the latest in a number of recent moves by central banks to ease monetary policy. Last week, the European Central Bank cut its key interest rate by a quarter of a percentage point to a record low of 0.75 percent in an effort to assist sagging growth in the euro area. China's central bank also lowered its key interest rate for a second time in a month.

In addition, the July rate cut was South Korea's first since February 2009, when the BOK lowered its policy rate by 50 basis points to a record low of 2 percent in the mist of the global financial crisis. The central bank then raised interest rates five different times between July 2010 and June 2011 to 3.25 percent, as low borrowing costs built up inflationary pressure.

Will it do much good?

In the FT's Beyond Brics blog, Simon Mundy says it's unclear how much domestic monetary policy can do to boost growth: "with a relatively small domestic market, South Korea's economy is geared heavily towards exports, and demand from major markets such as China and the EU has been flagging this year. While the won fell 0.7 per cent against the dollar on Thursday, the impact of limited monetary easing on the currency can hardly be a panacea in these circumstances."

"Moreover, bank lending rates to consumers and businesses have become decoupled from the base rate, so this cut will do little to boost the availability of credit, argues Ronald Man, an economist at HSBC."

Similarly, Peter Park, an analyst at Woori Investment & Securities said: "Given the protracted fiscal crisis in Europe and growth risks in China and the U.S., the global economy is increasingly heading for recession. We forecast that the BOK rate cut alone this time will not be good enough to guard against the slowdown pressure at home and abroad."


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