BOK holds rate unchanged at 3.5%, prioritizing economic stability

Bank of Korea (BOK) Governor Rhee Chang-yong bangs the gavel at the Monetary Policy Board held at the Bank of Korea in Seoul on July 13. [Photo by Yonhap]

The Bank of Korea has decided to keep its benchmark rate unchanged at 3.5 percent on Thursday, on concerns that a potential economic slowdown triggered by a rate change in the midst of already sluggish exports and the recent delinquency scandal at the MG Community Credit Cooperatives.

Especially given that the consumer price inflation rate dropped to the 2 percent range last month for the first time in 21 months, the central bank seems to have no reason to unnecessarily raise interest rates.

With the latest rate freezing, the monetary policy board at the central bank has kept the rate at 3.5 percent for almost six months, following its decision in February, April and May.

Earlier in March 2020, the BOK made a significant rate cut, reducing the rate by 50 basis points at once to 0.75 percent from 1.25 percent in anticipation of an economic downturn due to the impact from the Covid-19 pandemic. In May of the same year, the rate was further lowered to 0.50 percent from 0.75 percent, resulting in a total decrease of 0.75 percentage points within a two-month period.

Following the cuts, the central bank maintained the rate for nine consecutive times until August 2021, when the central bank finally raised the rate by 25 basis points to normalize monetary policy.

The benchmark rate has been raised eight times by 25 basis points, and twice by 50 basis points, resulting in 3.00 percent points hike since then.

However, the rate hikes since August 2021 was effectively broken by the February freeze, and the 3.5 percent benchmark rate has been in place for nearly six months to this day.

Behind the central bank’s decision is the economic instability amid slower-than-expected economic recovery due to sluggish export and domestic demand, and a rebound in the second half is not certain.

BOK Governor Rhee Chang-yong speaks at a press conference on the Monetary Policy Board’s interest rate decision held at the Bank of Korea in Seoul on July 13. [Photo by Yonhap]

In line with the forecast, the Ministry of Economy and Finance lowered its growth forecast for this year by 0.2 percentage points to 1.4 percent from the initial 1.6 percent as it released the economic policy direction for the second half of the year earlier this month.

In late May, the BOK also lowered its growth forecast to 1.4 percent, citing that the recovery of the semiconductor and information and communication technology industry, was not evident and the effect of China’s reopening was smaller than expected.

“As exports and domestic demand remain sluggish, the second quarter growth rate compared to the earlier quarter is likely to fall short of the BOK’s initial forecast of 0.6%,” said Park Jeong-woo, an analyst at Nomura Securities Co., forecasting the central bank to keep the key rate unchanged considering the economy ahead of the announcement.

The recent delinquency scandal at the MG Community Credit Cooperatives is also believed to be a reason for the rate freeze.

“The recent delinquency scandal raising concerns of potential financial market crunch, and the real estate project financing as well as non-banking financial sectors are also unstable,” said Joo Won, director at Hyundai Research Institute.

In the meantime, inflationary pressures, the largest trigger for rate hikes, have decreased noticeably. In June, consumer prices rose 2.7 percent year-on-year. It was the first time in 21 months that inflation had been above 2 percent since September 2021 when the figure was 2.4 percent.

The BOK kept the key interest rate unchanged again on the day, keeping the rate gap with the U.S. at 1.75 percentage points.

If the U.S. Federal Reserve Board (Fed) raises its policy interest rate by 0.25 percentage points by the end of this month as expected, it could result in an unprecedented 2.00 percentage point gap between the two countries. Such a widened gap may trigger increased pressure from foreign capital outflows and lead to the depreciation of the Korean won.