By Song Jung-a and Stefan Wagstyl
War threats or no war threats, the Bank of Korea is keeping a cool head.
Despite the crisis with the North and political pressure for rate cuts to boost flagging growth and push down the won in response to the yen shock, the central bank on Thursday left its policy rate unchanged at 2.75 per cent. But for how long it can resist the calls for cuts is moot.
Investors reacted to the news with a surge of won purchases, also driven by hopes that North-South tensions might be easing. The won jumped nearly 1 per cent against the US dollar before later falling back and trading 0.8 per cent stronger at Won 1128. Coming against a background of rate-cut forecasts, it was the biggest one-day rise in two weeks – which naturally won’t please the country’s hard-pressed exporters.
But it may only be a matter of time before the central bank does announce a rate reduction. The central bank made clear in its statement that the economy remained weak:
Going forward, there is no change to the Committee’s forecast that the domestic economy will show a negative output gap for a considerable time, due mostly to the slow recovery of the global economy and to the influence of Japanese yen weakening.
But the bank seemed to be a bit concerned that the recent falls in the won against the dollar (as opposed to its strength against the yen) and in the stock market should not go too far too quickly. The words financial instability don’t appear but with Pyongyang threatening nuclear Armageddon, you can see why the central bank might have decided to keep its powder dry.
In the financial markets, stock prices have fallen substantially and the Korean won has depreciated significantly against the US dollar, as foreigners’ securities investment funds have flowed out in line with the reemergence of euro area risk and with the increase in geopolitical risk in Korea. Long-term market interest rates have continued their downtrend, primarily on concerns about the slowdown in economic recovery.
That said, the pressures to cut rates to boost growth won’t go away. Capital Economics said in a note on Thursday:
Today’s decision to leave rates on hold was expected by around half of all analysts polled by Bloomberg, including ourselves. It means interest rates in Korea have now been left unchanged since October. However, policy is unlikely to be left on hold for much longer. Low inflation [1.3 per cent year-on-year in March] certainly means there is scope for rate cuts. …Meanwhile, the economy is likely to remain weak this year. Exports will remain a drag on growth if, as we expect, global growth disappoints again this year.
The central bank has faced calls from the government to ease its monetary policy as the country’s new president Park Geun-hye is keen to kick-start the stalled economy, which grew at its slowest pace since the global financial crisis in the first quarter.
The Korean government last month cut its growth forecast for this year to 2.3 per cent from its previous estimate of 3.0 per cent, citing weak exports and sluggish domestic consumption.
The government will draw up a supplementary budget this month, which will be large enough to restore market confidence, the finance minister said late last month.
Finance minister Hyun Oh-seok has vowed to use “all possible measures to speed the economic recovery,” as the yen was “flashing a red light” for Korean exporters. South Korea’s exports grew by just 0.5 per cent in the first quarter from a year earlier, as the Korean won has gained nearly 7 per cent against the Japanese yen so far this year.
Government officials in Seoul want rate cuts for policy coordination as they prepare various measures to prop up the economy, including the extra budget. The government plans to front-load 60 per cent of its 2013 budget into the first half and has announced measures to address the high household debt and stagnant property market – the two main factors which have been holding back domestic consumption. The government is also preparing measures to reduce volatility in the foreign exchange market.
At the end of the day, the central bank will probably do its bit to boost the economy. But it will bide its time – and in the process it will demonstrate its independence in the face of a new administration. Which will be no bad thing.
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