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Summary
- In the situation where the interest rate gap between the US and Korea narrows to 1.5%, experts say that an interest rate cut is necessary, but the burden on the Bank of Korea is significant.
- Lee Chang-yong, Governor of the Bank of Korea, recently expressed the opinion that the exchange rate has become a concern at the October Monetary Policy Committee meeting.
- Experts predict that Korea will not continue to lower interest rates after the November FOMC, citing the side effects of a rapid interest rate increase.
Korea-US Interest Rate Gap 1.5%%P
Exchange Rate Policy 'Variable' Changes
US Interest Rate Lowered, but Exchange Rate Remains High
Still High at 1380 Won Level
Increase in Household Debt Also Noted
Experts Say "Interest Rate Freeze Likely"
Economic Burden Requires Lower Rates, but
Two Months of Consecutive Rate Cuts 'Speed Adjustment'
Lee Chang-yong, Governor of the Bank of Korea. Photo=Kim Beom-joon, Korea Economic Daily Reporter
The US Federal Reserve (Fed) lowered its policy interest rate by 0.25 percentage points, but the Bank of Korea's exchange rate policy remains uncertain. Although the won-dollar exchange rate, which surged before the US presidential election, has slightly decreased (appreciation of the won), it is not at a reassuring level, and household debt issues have not been resolved. The expectation is that it will be difficult for the Bank of Korea to continuously lower the interest rate, which started the pivot (exchange rate policy shift) last month.
Narrowed Korea-US Interest Rate Gap
On the 7th (local time), the Fed decided to lower the policy interest rate from 4.75-5.0%% to 4.50-4.75%% by 0.25 percentage points at the Federal Open Market Committee (FOMC) regular meeting, narrowing the interest rate gap with Korea (3.25%%) from 1.75 percentage points to 1.50 percentage points.
The interest rate gap between the two countries stimulates capital movement towards the higher interest rate side. The higher interest rate in the US is a factor that draws capital outflows from Korea and increases the won-dollar exchange rate.
With the Fed's interest rate cut, the interest rate gap has narrowed, and the exchange rate fell on this day. In the Seoul foreign exchange market, the won-dollar exchange rate (as of 3:30 PM) traded at 1386.40 won, down 10.20 won from the previous day.
Although the Fed's interest rate cut was a relief for the exchange rate, the level remains high. The exchange rate rose more than 6%% from 1307.80 won at the end of September. Lee Chang-yong, Governor of the Bank of Korea, recently stated in a meeting with reporters that "the exchange rate, which was not a concern at the October Monetary Policy Committee, has become a concern."
Another key factor in the Bank of Korea's interest rate decision is the financial stability situation, which is not severe. Although the financial authority's household debt increase, which surged to 10 trillion won in August, decreased significantly to 5 trillion won in September, it rebounded to 6 trillion won last month.
Despite Growth Concerns, 'No Change' in November Decision
Despite this, the price and growth indicators strongly suggest the need for an interest rate cut. The consumer price index rose 1.3%% last month, the lowest level since January 2021 (0.9%%). The need to maintain high interest rates for price stability has disappeared.
The domestic gross domestic product (GDP) grew by 0.1%% in the third quarter. According to the International Monetary Fund (IMF), several global investment banks (IBs) recently lowered their growth forecasts for Korea this year from 2.5%% to 2.3%% by 0.2 percentage points. This governor also stated last month that "the possibility of this year's growth rate falling below 2.4%% (the Bank of Korea's previous forecast) is high," suggesting a range of 2.2-2.3%%. The reason for the growing call for an interest rate cut is to alleviate the economic burden.
Experts predict that the possibility of lowering the base rate at the Monetary Policy Committee meeting on the 28th of this month is low when considering such a dilemma comprehensively. Cho Young-gu, a researcher at Shinhan Financial Investment, predicted that "as the exchange rate increase is more burdensome than economic deterioration, the Bank of Korea will decide to freeze the interest rate this month."
The Bank of Korea emphasizes that the situation in Korea is different from that of the US, which continuously lowered interest rates at the FOMC in November following September. A Bank of Korea official said, "While the US raised interest rates rapidly from 0-0.25%% to 5.25-5.50%% annually, Korea raised them by 3 percentage points from 0.50%% to 3.50%% annually," adding, "As the pace of increase was faster, the pace of decline will also be felt." It is analyzed that Korea does not have to choose continuous rate cuts like the US.
The possibility that the US interest rate cut speed could be faster than market expectations due to Donald Trump's victory in the presidential election is also a factor that supports the 'speed adjustment theory.' If Trump's definitive fiscal policy, tax cuts, and other measures become a reality, it could act as a factor for price increases.
Yoo Sang-dae, Deputy Governor of the Bank of Korea, said at a market situation inspection meeting related to the US presidential election and FOMC on this day, "The uncertainty surrounding the major countries' exchange rate policies has increased," adding, "We will closely monitor the impact of US policy changes on our financial and economic conditions and respond as needed."
Reporter Kang Jin-kyu josep@hankyung.com
