Stuck in neutral

Central bank keeps Korea’s key interest rate on hold

By Kim Tong-hyung

The Bank of Korea’s (BOK) monetary policy committee kept interest rates at 3.25 percent for the seventh consecutive month Friday amid concerns about the strength of the economic recovery and the eurozone debt crisis. It bears further watching how much longer rate setters can resist the urge to slash when the economy threatens to break for the worse.

Policymakers here are also concerned over the fallout of the international tension surrounding Iran and its suspected pursuit of nuclear weapons, fueling another spike in energy costs.

Speaking to reporters after the rate-setting meeting, BOK Governor Kim Choong-soo admitted that the subduing of economic activity has been worse than feared, saying that the pullback in gross domestic product (GDP) for the fourth quarter last year could be sharper than expected.

``There is no need to talk about a contraction yet. But we had expected an on-quarter growth of 1 percent and an annual increase of 4 percent, and it appears now that economic activity was softer than that,’’ Kim said.

``Our expectation for consumer price inflation is at 3.3 percent for this year, but there are possibilities that the political instability in the Middle East and other factors will result in increased volatility.’’

Despite persisting inflationary pressure, a clampdown on money supply is obviously not an option when the heady mixture of negatives surrounding the country from inside and out threatens to derail its fragile recovery. Kim downplayed speculation that the BOK is considering other alternatives, such as increasing capital reserve requirements at banks, to let the air out of prices.

``Controlling reserve ratios or loan ceilings could be options for monetary policy, but the benchmark rate will continue to be our main tool,’’ Kim said.

Keeping the benchmark rate lower than the pace of consumer price inflation, which was measured at 4 percent for the whole of 2011, continues to be an uncomfortable decision for the central bank, which has been powerless to halt the damage to spending power and savings.

Inflation has resulted in an acute squeeze in living standards here, further tormenting families sinking under a sea of debt. However, economic policy will continue to favor borrowers over savers as long as the government has to put growth before price stability.

Korea’s consumer debt mountain currently scales at around one quadrillion, which means that households collectively owe more money than the economy generates in a year. While the nationwide borrowing binge was fueled by speculative demand for property in the past decade, lower-end borrowers have been contributing increasingly to the body of debt in recent months as they struggle to support the higher cost of living.

BOK’s decision to sit on its hands on borrowing costs will obviously offer some respite for cash-strapped households. But critics claim rate setters could be playing with fire by extending expectations of low interest rates and further encouraging borrow-to-spend habits.

``Domestic economic growth will gradually return to its long-term trend level going forward, after remaining subdued for some time due mostly to the impact of external risk factors,’’ the BOK said in a statement.

Ronald Man, an economist at HSBC Global Research, predicted that the slew of threats facing growth will force the central bank to cut its benchmark rate within the first quarter of the year.

``The BOK now projects economic activity to drop below the long term trend for some time. High inflation expectations are the last man standing. Once they come down, the Bank of Korea can comfortably ease policy rates,’’ he said in an e-mailed statement.

``With growth concerns dominating the scene, the Bank of Korea has clearly shifted to a more dovish position. Elevated headline consumer price index and inflation expectations readings have held the Bank of Korea from cutting rates to support growth in January. But both are likely to come down over the coming months.’’

While Korea last month joined the U.S.-led efforts to impose sanctions on Iranian firms and individuals to weaken Teheran economically and derail its alleged pursuit of nuclear weapons, policymakers here have been resisting pressure from Washington over reducing or halting the country’s oil imports from the Middle East nation.

The country bought 72.6 million barrels of crude oil from Iran last year, about 8.3 percent of its total oil imports, according to the Korea National Oil Corp, and a sudden halt in supplies would cause a major disruption here.