INTERVIEW BOK faces daunting rate dynamics: global credit rating agencies, IB economists

Seen in this photo is Bank of Korea Gov. Rhee Chang-yong during the National Assembly's strategy and finance committee hearing at the Assembly building in Yeouido, Seoul, Wednesday. Yonhap

The Bank of Korea (BOK) will be in a bind over the pace of monetary easing next week, complicated by currency volatility, the stagnant economy, weakness in export growth and delayed expectations of the U.S. Federal Reserve (Fed) rate cuts, economists at global credit agencies and investment banks said Thursday.

Many say the Feb. 25 rate cut is a foregone conclusion, as warranted by prolonged anemic domestic spending and slowing export growth.

A failure in timely monetary easing will further deteriorate the already struggling economy, due to years of postpandemic monetary tightening that pushed up borrowing costs amid sticky inflation, some economists noted.

Others say a pause is a more likely outcome, given the recent muted Korean currency volatility and an uptick in inflation last month. Also at play is the recent hawkish turn of the Fed, influenced largely by hot inflation prints and a strong labor market in the world’s largest economy.

Louis Kuijs, APAC chief economist at S&P Global Ratings / Courtesy of S&P Global Ratings

Louis Kuijs, APAC chief economist at S&P Global Ratings said the BOK is in an easing cycle.

“The BOK will bring its policy rate down this year, given the progress made with containing inflation and soft growth outlook,” he said in an interview with The Korea Times.

A Feb. 25 rate cut is justified due to recently weakening growth and other domestic considerations, he added.

However, the BOK may well decide to delay the cut. "The BOK can be unsettled by the depreciation pressure on the foreign exchange market and uncertainty about U.S. interest rates and trade tariffs," Kuijs said.

Dave Chia, associate economist at Moody’s Analytics, said the central bank will cut the rate next week.

“We expect the [BOK] to cut its policy rate by 25 basis points to 2.75 percent later this month,” he told The Korea Times.

A weak currency and the economy's underperformance will be key considerations, Chia noted.

Moody’s Analytics Associate Economist Dave Chia / Courtesy of Moody’s Analytics

“The volatile and weak won has regained some ground since its December tumble. The central bank will monitor the currency in the days leading up to the monetary policy decision," he said.

Sluggish domestic demand, as illustrated by recent gross domestic product (GDP) and retail sales data, is a long-standing concern, he added.

“Export growth, a critical driver of the economy, could also moderate due to changing external conditions. New U.S. tariffs under the Trump administration and slowing growth across major export categories could hinder export momentum and Korea’s economic growth.”

Chia said fiscal and monetary remedies are needed. “There is an opportunity for extra fiscal stimulus to boost the economy with a supplementary budget under consideration. However, the government will want to move cautiously to stay within its fiscal targets.”

He warned about the BOK falling behind the curve, a constant source of pain and criticism for BOK Gov. Rhee Chang-yong. “Failing to cut the policy rate in a timely manner could exacerbate weak domestic demand, especially considering delays associated with monetary transmission.”

Caroline Wong, APAC country risk analyst at Fitch BMI /Courtesy of Fitch BMI

But Caroline Wong, APAC country risk analyst at BMI, a Fitch affiliate, said the central bank is expected to leave the rate unchanged.

"The BOK's policy rate setters' concerns over foreign exchange developments are easing, as indicated by the Korean currency's strengthening by about 1 percent since last month’s meeting," she said.

However, inflation edged higher to 2.2 percent last month from a year ago. This trended back above the central bank target of 2 percent and was up from 1.9 percent in December last year.

“Import prices rose for a fourth consecutive month in January, suggesting that inflation could remain elevated in the near term. Global factors are at play, too, with the Fed indicating that it is in no rush to cut rates," she said.

Collectively, these factors indicate that a cut at this point could weigh further on the Korean currency's movements, she added.

Not only would interest rate differentials between the U.S. and Korea widen, but the subsequent increase in imported inflation would undermine the BOK’s efforts to ensure price stability.

Easing monetary conditions could in turn lead to a renewed buildup in household debt — an outcome the BOK will be mindful of avoiding at this point.

“While there is a need to spur growth as the ongoing political turmoil continues to take a toll on the health of the economy, we think the BOK is keen for fiscal policy to play a bigger role in stimulating domestic demand, as opposed to resorting to monetary policy alone," Wong said.

Goldman Sachs economist Kwon Goo-hoon said the BOK is expected to resume easing next week.

“The resumption in easing would be consistent with a unanimous forward guidance in the January meeting in the near term,” he said in a report.

Underlying the projection are sustained weaknesses in domestic demand, reduced U.S. trade policy uncertainties and tempered household leverage amid cooling housing markets.

“Implementation of a strategic foreign exchange hedging policy by the National Pension Service should also help reduce constraints on BOK monetary policy," he said.

BNP Paribas Korea economist Yoon Jee-ho echoed Kwon's remarks.

“We expect a 25 basis point cut next week, since financial stability concerns have seemingly eased," he said. "The BOK is likely to caution against building expectations of excessive rate cuts. The central bank may say that it will observe effects of the previous rate cuts or that there is a need to preserve policy room.”