BOK likely to hold in January despite Fed's 3 consecutive rate cuts

Bank of Korea (BOK) headquarters in Seoul / Courtesy of BOK

The Bank of Korea (BOK) is widely expected to hold steady in January, despite three consecutive rate cuts by the U.S. Federal Reserve, hamstrung by sustained sharp weakness of the Korean currency and persistent rise in household debt, market watchers said Thursday.

The Korea-U.S. interest rate differential has narrowed to 1.25 percentage points, limiting concerns about foreign capital outflow.

However, a recent sharp demand for the U.S. dollar driven by asset managers including the National Pension Service and retail investors seeking increased holdings in the U.S. equity remains a key deterrent for the central bank against further monetary easing.

Many say Korea is in a “monetary policy bind," with external conditions strengthening the case for easing, while domestic concerns make it risky. The central bank is likely to hold steady as the Fed hinted at a slower pace of easing.

The Fed lowered the federal funds rate by 25 basis points this week to 3.50-3.75 percent, its third straight cut following September and October.

The Fed said in its statement that downside risks to employment have increased in recent months, citing the slowdown in the labor market as a key reason for the rate cut.

However, markets have characterized the move as a “hawkish cut,” since Fed Chair Jerome Powell also hinted that the pace of cuts could slow, stressing the policy rate remaining within the estimated neutral range.

The Fed easing gives Korea’s central bank greater room to maneuver. However, sustained won weakening is unlikely to be tempered any time soon.

BOK monetary policy board member Kim Jong-hwa said Wednesday that about 70 percent of recent won weakness is explained by dollar supply-demand dynamics, not Korea-U.S. interest rate differentials.

Strong overseas investment flows from Korea's pension fund and retail investors upping U.S. equities led to sharp increase in U.S. dollar demand.

“Market participants are acting rationally seeking higher returns abroad, but taken together, these behaviors have produced the negative macroeconomic outcome of a persistent currency weakness,” he said.

The Korean currency slid to 1,477.1 won against the U.S. dollar Nov. 24 — the weakest weekday daytime closing price since April 9, when it dipped to 1,484.1 won against the dollar amid heightened concerns over U.S. tariff volatilities.

The currency weakness has since continued in a range between the 1,460s and the 1,470s.

The continued property market overheating also complicates monetary easing.

The price increases across the broader Seoul metropolitan area have moderated, but select districts remain far from cooling, a development that warrants against rate cut and subsequent cheaper liquidity.

The central bank is likely to continue to be against monetary easing if the housing market status quo continues into January.

“A rate cut will not be in the picture unless the currency movement rapidly stabilizes, with clear signs of property market cooling,” Standard Chartered Korea economist Hong Dong-hee said.

“Only then will easing be on the table with evidence that next year’s growth momentum is weaker than expected.”