By Kim Jae-kyoung
Staff Reporter
The central bank is likely to take more aggressive steps than widely expected at its November monetary policy committee meeting scheduled for Friday, with impaired monetary mechanisms weakening the efficacy of rate cuts.
In its latest report, Citigroup said that it expects the Bank of Korea (BOK) to cut rates another 25 basis points, extending its aggressive policy rate cuts. The central bank slashed rates by a total of 100 basis points in October to forestall a recession.
``Mounting evidence of slower economic growth from industrial activity and export data clearly supports further monetary easing,'' Citi economist Oh Suk-tae said.
``More aggressive action, such as a 0.5 percentage-point rate cut or more direct liquidity provision to financial markets, might be needed to really impress the market and extend the rally,'' he added.
He pointed out that any disappointment such as no rate cut or a rate cut with hints about a pause would likely lead to a significant sell-off in bonds given the fragile market sentiment.
Some analysts said that more aggressive rate cuts and fiscal spending are highly likely, as monetary mechanism have been impaired in the wake of the global financial meltdown, with consumer and business sentiment tumbling.
The business sentiment index for manufacturing and non-manufacturing for November plunged to record lows of 65 and 63, respectively. The consumer sentiment index also dipped to 88 in the third quarter from 96 a quarter ago.
Once the central bank delivers monetary prescriptions, its effects make their way through the economy through a number of mechanisms ― real interest rate, credit availability and liquidity. But these mechanisms have been impaired, limiting the effect of the rate cut
``Given the massive shocks hitting the world economy and the impaired mechanisms of monetary policy, the rate cuts stand to have only a small impact in reversing the slowdown,'' Barclays Capital economist Paul Sheard said in a research note.
For example, it is widely believed that rate cuts boost asset prices, such as equity and home prices, which then stimulate consumption. But with daunting falls in real wealth in recent months, the effect that rate cuts can have on the economy by boosting consumers' wealth is small.
``We believe a round of expansionary fiscal policies is needed for policy easing to have tangible real effects,'' he added. ``In the current crisis circumstances, the efficacy of monetary policy is in doubt, and more than fine-tuning may be required.''