INTERVIEW BOK forecast to cut rate in Q4 amid contained downside risks: J.P. Morgan economist

Park Seok-gil, executive director of JPMorgan Chase Bank Asia Economic Research / Courtesy of J.P. Morgan

The case for a fourth-quarter dovish pivot by the Bank of Korea (BOK) is strengthening, underpinned by its policy priority of tempering inflation to a stable 2 percent despite stronger-than-expected growth in the first quarter, according to a senior J.P. Morgan economist, Thursday.

The pace of Korea’s output gap turning positive continues to complicate the inflation dynamics. However, the development is not nearly significant enough to alter the course of monetary easing, according to Park Seok-gil, executive director of JPMorgan Chase Bank Asia Economic Research. The gap refers to the difference between actual output of an economy as measured by the GDP and its potential. A positive gap means an economy overshooting its full-capacity output, whereas a negative gap means GDP undershooting its potential.

The strong net exports oriented toward the IT sector's boom cycle are, in his view, expected to offset flagging domestic demand, pushing up the country’s annual GDP growth to 2.8 percent from a year earlier.

The positive and fuller impact of forward guidance, a communication tool implemented by BOK Governor Rhee Chang-yong to bolster monetary policy efficacy, will be assessed over the rate-setting meetings to come, according to the former International Monetary Fund (IMF) economist.

Bank of Korea Gov. Rhee Chang-yong bangs the gavel to open a Monetary Policy Committee meeting at the central bank in Seoul, May 23. Yonhap

'Festina Lente': Better late than premature

“In our view, the risks associated with a too-early shift will remain slightly greater than those of a too-late shift over the next two or three months,” he said during an interview with The Korea Times.

Expectations of a third-quarter rate cut have increased, fueled by monetary easing in advanced economies including Europe as well as advancing views on a near-term rate cut by the U.S. Federal Reserve. Also at play is calls from a top adviser to President Yoon Suk Yeol on an expedited easing to relieve debt service burdens for low-income borrowers and small businesses.

However, the BOK has yet to turn dovish, mindful of the so-called “last mile” risks, as best encapsulated by Rhee's approach of “Festina Lente,” the classical adage and oxymoron meaning “make haste slowly."

A premature easing risks not only a delay in tempering inflation to the central bank target of 2 percent, but also elevating foreign exchange volatility and an unmuted growth in household leverage.

In contrast, a stalled easing can sap the economic vigor, as illustrated by the already significant gap between robust exports and softening domestic demand. Also deepening will be financial market vulnerabilities, exacerbated by delinquencies in the real estate market and insolvencies of low-credit borrowers.

All in all, the risks of a premature easing will not be subdued over the next quarter, in his view.

“A significant change in the BOK economic and policy assessment will warrant a rate cut in the third quarter, as summarized by our review of the monetary policy meeting minutes and the BOK version of the dot plot,” he said. “We maintain that signals for a rate cut will intensify in the third quarter. An actual rate cut is likely to occur in the fourth quarter.”

In the May meeting, the central bank concluded that a restrictive stance was appropriate at the time, given the improvement in GDP growth and the heightened upside risks to inflation.

This means a third-quarter rate cut would require a significant increase in downside risks to growth and inflation compared to the May assessment — an unlikely scenario due to a lack of data for reference, he said.

“The July meeting will be held before the second-quarter GDP is confirmed,” he said. “The rate-setting members of the BOK monetary policy committee will not be able to significantly alter their macroeconomic outlook from the May assessment, due to the scarcity of new and significant information on domestic demand.”

Forward guidance

The former BOK employee said Rhee's initiative of forward guidance is an effective measure for managing the market participants’ expectations on the rate trajectory.

“The verbal guidance was introduced in the fourth quarter of 2022 — less than two years ago, but the track record so far suggests that the BOK-style dot plot provides useful information on the rate path,” he said.

In the May meeting, only one of the six members was open to the possibility of a rate cut within the following three months, in what market analysts considered an indication against a rate cut in the third quarter.

“Expectation of a rate cut no earlier than October was well within reason, with the risk of August action based on June consumer price index (CPI) reading emerging,” Park said.

Forward guidance should be more about outlining an overall path and direction of the monetary policy, not a means of precise gauge for timing for a rate cut, in his view.

Market participants are wired to look for a clue to identify the precise target level of inflation that would necessitate a rate cut, as referenced from the BOK head. But forecasts by definition do not mean a 100 percent certainty, he added.

“The impact and efficacy of verbal guidance will be a vibrant topic for academic discussions,” he said.

gettyimagesbank

May meeting minutes

The primary focus for the economist with an immediate objective to identify clues for rate cuts was each of the committee members' assessment of the stronger-than-expected 1.3 percent quarter-on-quarter growth.

“Their opinions on the current inflation and future outlook varied," he said. "However, the robust growth exceeding expectations argues against a swift rate cut in the near term, fortifying my projections. I found fewer implications of a significant policy pivot within the next three months except the soft June CPI data.”

The most dovish member of the monetary policy committee indicated that conditions for a rate cut are “gradually being met” from an inflationary perspective, while downplaying the probability of a sharp depreciation of the Korean currency.

“Our assessment suggests this member's dovishness increased from April to May, indicating the possibility of a dissent vote in the third quarter,” Park said.

Other members remain cautious about the upside risks to inflation, household debt growth and currency volatility.

“The committee members remain predominantly hawkish. A few more months may be needed before implementing a rate cut,” he said.

Soft June data

While the baseline view of the global investment banking powerhouse is for the rate cut to come in the fourth quarter, the decision between an August or October action will be complicated by the soft June data.

"Given the more stable inflation figures by June, the dovish tone from the committee should be reinforced in July, increasing the likelihood of a rate cut in August. The decision between an August or October action will be a close call."