Korean rate cuts

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Central bank makes unexpectedly generous cut in interest rates and hints at more to come. Traders whoop with glee and the stock market registers its biggest one-day gain in four years. Sound familiar? Some 13 months after the Federal Reserve (temporarily) delighted US markets with a 50 basis point cut in interest rates, South Korea On Monday slashed its policy rate by 75bp. That comes just weeks after a first cut, and brings the policy rate to 4.25 per cent.

We know how quickly the smiles were wiped off faces in the US. But in Korea they barely appeared. The stock market gained less than 1 per cent and the won continued its slump against the dollar. Bank funding costs barely budged.

Cheaper debt servicing certainly helps a country awash with the stuff. Household debt was over 80 per cent of GDP at the end of the second quarter, while businesses add another 95 per cent. But much of the former comes from home loans and credit cards, whose inflated charges make a 75bp cut helpful if not life-changing. Planned tax cuts are likewise a step in the right direction, albeit a small one. Assuming an average lending rate of 7.5 per cent (most mortgages in Korea have floating rates, linked to three-month certificates of deposit), the mooted $9bn fiscal package represents barely three months’ interest payments for households.

As Monday’s market reaction illustrates, every solution has a destructive element. Lower borrowing costs should stimulate growth, but might discourage foreigners from holding won-denominated assets. Low interest rates plus a weak won also add to inflationary pressures at a time when consumer prices are outpacing the central bank’s targets. In contrast to the 1997 crisis, Korea has the financial firepower to stimulate economic growth and support its currency. As in the US, expect more to be spent before the fires abate.

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