South Korea -X-Press Benchmark Interest Rate Reduced in South Korea Event

Global Economics
Tuuli McCully 1 (416) 863-2859
tuuli.mccully@scotiabank.com
October 15, 2014
South Korea-X-Press
Neil Shankar 1 (416) 866-6781
neil.shankar@scotiabank.com
Benchmark Interest Rate Reduced in South Korea
Event
The Bank of Korea (BoK) lowered its benchmark interest rate by 25 basis points (bps) to 2.00% on October 15th.
Significance
The BoK implemented additional monetary stimulus in hopes of bolstering the struggling economic recovery
amidst greater financial market volatility and its potential adverse impact on sentiment. However, the move also
increases the risk of household debt reaching higher levels; partly due to this concern, the BoK will likely maintain
the current monetary policy stance in the coming months.
Market Reaction
The South Korean won (KRW) strengthened against the US dollar (USD) following the Monetary Policy
Committee’s (MPC) announcement. The statement issued by the MPC indicated that the central bank will likely
pay greater attention to financial stability going forward, as well as its concern regarding the vast depreciation of
the KRW vis-à-vis the USD and net sell-off of stocks by foreign investors. Accordingly, and despite the rate cut,
the currency is trading at USDKRW1063 at the time of writing, 0.6% stronger on the day. We expect the won to
close the year at 1060 per USD. Meanwhile, the Korean benchmark KOSPI Index remained virtually unchanged
on the day; the index has slid 4.2% year-to-date.
Analysis and Outlook
Today’s decision takes the BoK’s base rate to the level observed during the February 2009 - November 2010
period, following the 2008 global financial crisis. The cut comes after an equivalent reduction following the
monetary policy meeting in August and is aimed at placing the economy on a steadier recovery track. We expect
the BoK to hold off from further monetary easing as the South Korean economy is set to strengthen in the coming
months; moreover, policymakers assess that while price pressures are currently low, the upside risks to inflation
outweigh downside risks. Concern over the already high levels of household debt (which reached around 85% of
GDP at the end of 2013) will also serve as a deterrent to future rate cuts.
BoK authorities point to gradually improving domestic consumption, steady employment expansion, and sustained
export sector growth in the externally oriented economy (South Korean exports of goods and services are
equivalent to 54% of GDP as of 2013) as indicators of sustainable economic growth over the medium term.
Nevertheless, policymakers also assess that facilities investment remains sluggish and that sentiment among
economic agents has only partially recovered. Furthermore, the authorities note that downside risks to the growth
outlook remain significant. Accordingly, the BoK revised its real GDP growth forecasts downwards, and now
expects the economy to expand by 3.5% in 2014 (from the earlier forecast of 3.8%) and by 3.9% in 2015 (from
4.0%).
The decision to ease monetary conditions for the second time since August further complements the
government’s US$40 billion stimulus package that was announced in July in an attempt to support household and
business spending as well as the real estate sector. The stimulus package has successfully contributed to the
recent upward trend in real estate prices in Seoul and its surrounding areas. Today’s decision was likely
influenced to some extent by persistent pressure from the South Korean government to cut rates, namely from
Finance Minister Choi Kyung-hwan, leading to some concerns regarding the central bank’s independence.
South Korean price expansion was at a 7-month low in September. The consumer price index rose by 1.1% y/y,
down from a 1.4% increase in August. The continued decline in petroleum product prices and near-zero producer
price inflation will contribute to negligible upside pressure on headline inflation over the medium term. We expect
inflation to remain muted in the coming months, closing the year at 1½% y/y, before accelerating slightly to around
2½ % by the end of 2015, at which point it will reach the lower boundary of the BoK’s 2½-3½% target range.
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October 15, 2014
Global Economics
South Korea-X-Press
INTERNATIONAL ECONOMICS GROUP
Pablo F.G. Bréard, Head
1 (416) 862-3876
pablo.breard@scotiabank.com
Erika Cain
1 (416) 866-4205
erika.cain@scotiabank.com
Estela Molina
1 (416) 862-3199
estela.molina@scotiabank.com
Neil Shankar
1 (416) 866-6781
neil.shankar@scotiabank.com
Scotiabank Economics
Scotia Plaza 40 King Street West, 63rd Floor
Toronto, Ontario Canada M5H 1H1
Tel: (416) 866-6253 Fax: (416) 866-2829
Email: scotia.economics@scotiabank.com
Rory Johnston
1 (416) 862-3908
rory.johnston@scotiabank.com
Tuuli McCully
1 (416) 863-2859
tuuli.mccully@scotiabank.com
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