Will the Bank of Korea implement additional rate cuts?

1. Bank of Korea implements a 0.25% rate cut.

1) 0.24% rate cut by Korean Bank

The Bank of Korea lowered its base interest rate by 0.25% to 3.25%, marking the first reduction in 38 months from the previous rate of 3.5%. The Bank of Korea had implemented a high-interest-rate policy to control inflation that arose during the COVID-19 pandemic. 

This was not unique to Korea but a global trend, significantly influenced by the high-interest-rate policy of the U.S. Federal Reserve (Fed), which effectively sets the global standard for interest rates. 

The Fed's 0.5% "Big Cut" has a profound impact on the global economy. 

The Fed’s decision to cut interest rates was driven by concerns over a potential domestic economic downturn, despite inflation in the U.S. having dropped to the 2% range. 

This was in light of the unemployment rate remaining at 4.2% and a slight increase in recent initial jobless claims, which totaled around 240,000. 

2) Korean Bank's option 

The recent decision by the Bank of Korea to lower the base interest rate from 3.5% to 3.25% was driven by both declining inflation and a slowing economy. 

South Korea's inflation rate fell to the 2% range in 2024, providing the central bank with room to ease its previously tight monetary policy. 

Before making this rate cut, the Bank of Korea faced a difficult choice: lowering the interest rate could lead to increased household debt, which is already at historically high levels due to reduced financial costs, while not lowering the rate could exacerbate concerns of deflation and a further downturn in domestic consumption.

 Ultimately, the Bank of Korea opted for a 0.25% rate cut, prioritizing economic stimulation over inflationary concerns.

2. Will the Bank of Korea implement additional rate cuts?

1) Rate Gap between Korean Bank and U.S. Fed 

The Bank of Korea must pay close attention to capital outflows and exchange rate volatility due to the interest rate gap with the United States. 

Currently, the interest rate gap between South Korea and the U.S. has widened to 1.75%, increasing the likelihood that foreign capital invested in South Korea may flow out in pursuit of higher returns abroad, which could lead to exchange rate instability. 

South Korea's household debt, which exceeds 100% of its GDP, is one of the highest in the world. Lowering interest rates reduces household interest burdens, increas disposable income and stimulate consumption, which helps boost domestic demand. 

2) Possibility about addional rate cut

However, it also reduces financial costs for purchasing real estate, potentially causing household debt to rise again. 

A rate cut could lead to a resurgence in the real estate market, potentially causing a property bubble or financial instability similar to what occurred in Japan in the past. Additionally, a rate cut could induce exchange rate volatility. 

If capital outflows increase, exchange rate fluctuations could significantly impact the Korean economy. 

As seen in Japan, where a sudden rise in the yen led to a surge in import prices, which in turn exacerbated the cost of living for the general population, a rate cut could trigger a sharp increase in the won-dollar exchange rate. 

This makes it imperative for the Bank of Korea to approach any rate cuts with caution. 

Although inflation in Korea has dropped to the 2% range, providing room for additional rate cuts, the Bank of Korea must carefully weigh the risks of rising household debt, potential capital outflows, and exchange rate volatility before proceeding with further rate cuts.