The Fed is about to cut interest rates. Will Korea follow?

Korea deliberates its interest rate amid U.S. rate cuts, with inflation at target levels but concerns over household debt and domestic demand stalling.

U.S. Federal Reserve Chairman Jerome Powell walks from a news conference in Washington on May 3, 2023, following the Federal Open Market Committee meeting. [AP/YONHAP]

The U.S. Federal Reserve is set to kick off its first rate-cutting cycle in years, but Korea remains cautious while weighing the timing of its own interest rate reduction.

Although Korea's headline inflation has slowed to the 2 percent target and weak domestic demand has fueled anticipation of long-awaited rate cuts, the continued growth of household debt remains a major challenge after the record surge in mortgage loans last month.

The U.S. central bank is to reveal its benchmark interest rate following the Federal Open Market Committee (FOMC) meeting from Tuesday to Wednesday. Markets widely expect that the decision, set to be announced overnight on Thursday, will mark the first rate reduction since 2020 amid slowing inflation and the recent growth in the United States' unemployment rate.

The FOMC has been holding the federal funds rate at its 23-year high of 5.25 to 5.50 percent since last July.

The European Central Bank has lowered its key policy figures twice so far this year, with the deposit facility rate falling from 4 percent to 3.75 percent in June and further to 3.5 percent this month.

As such, pressure is mounting for the Bank of Korea (BOK) to begin rate reductions as well. The Korean central bank held its base interest rate steady at 3.50 percent for the 13th straight meeting in August.

During a news conference after the latest rate-setting meeting, BOK Gov. Rhee Chang-yong said, “We should not make the mistake of fueling real estate prices by increasing liquidity with easing measures such as lowering rates,” emphasizing financial stability.

However, a senior official from the presidential office expressed rare dissatisfaction following the BOK’s Monetary Policy Board meeting last month, stating that “while setting the interest rate is at the central bank’s sole discretion, it still leaves something to be desired in terms of stimulating domestic demand.”

In a recent report published Sept. 6, the Hyundai Research Institute urged the BOK to “actively consider a policy pivot with interest rates, starting at least with the upcoming rate-setting meeting.”

The think tank stressed that “while the Monetary Policy Board’s reasoning behind the recent decision, which involves the household debt trend and the jittery real estate market, is not invalid, we believe the current time calls for appropriate monetary policy considering that consumption and investment remain sluggish due to high interest rates.”

Meanwhile, a report from Samsung Securities suggested that the Korean stock market is likely to trend upward following U.S. rate cuts.

“The previous stock market drops during rate-cutting cycles were mainly caused by the weak U.S. economy, but recent economic indicators show that the U.S. economy remains relatively stable,” said Shin Seung-jin, an analyst at Samsung Securities, adding that “the [expected] rate cut should be deemed a pre-emptive measure rather than a recession cut.”

The Monetary Policy Board has two remaining rate-setting meetings scheduled for this year, with one on Oct. 11 and the other in November.

BY SHIN HA-NEE [shin.hanee@joongang.co.kr]