South Korea’s central bank cut its benchmark interest rate by 25 basis points to 3.25% after holding it steady for nearly two years. The Bank of Korea’s decision to pivot comes after the U.S. Federal Reserve slashed rates by 50 basis points last month, and Korea’s headline inflation fell below the central bank’s 2% target, cooling to 1.6% in September.
The BOK lowered the benchmark seven-day repurchase rate by a quarter percentage point to 3.25% at the monetary policy meeting held on Oct. 11, ending its longest rate freeze run, which lasted for a year and seven months. The BOK has kept the interest rate unchanged at 3.5% since February last year, holding it steady through 13 consecutive meetings.
The central bank stated, “Inflation is showing a clear trend of stabilization, and household debt growth is slowing down after the government implemented macroprudential policies.” The monetary policy board added that “foreign exchange market risks have also somewhat eased, so the board saw that it was appropriate to slightly ease the degree of monetary tightening.”
The central bank’s last rate cut was in May 2020. The BOK began raising interest rates in August 2021 to curb inflation, which had surged to 6% during the COVID-19 pandemic. Between August 2021 and January last year, the BOK raised rates from 0.5% to a 15-year high of 3.5%, then stood pat since February last year as concerns about an economic slowdown emerged.
The BOK’s rate cut decision was widely anticipated, with 64 out of 100 market analysts polled by the Korea Institute of Financial Investment responding that they expected the central bank to lower interest rates at the October meeting.
Experts pointed out that the Fed’s jumbo rate cut narrowed the interest rate differential between the U.S. and Korea from 2 percentage points to 1.5 percentage points. A smaller rate differential reduces the risk of capital outflows, giving the BOK more room to lower rates, which it had been reluctant to do for fear of triggering such outflows.
The BOK’s rat cut decision was also influenced by cooling inflation and weakening demand. The consumer price index rose 1.6% year-on-year in September, dropping under 2% for the first time since March 2021. “From the perspective of domestic demand, the need for a rate cut is increasing, said Shin Sung-hwan, a “dovish” member of the monetary policy board. “the Korean economy cannot afford to wait until housing prices definitively cease rising.”
The slowdown in household debt growth also strengthened the case for a rate cut. Data from the financial sector showed that the balance of mortgage loans at South Korea’s five largest banks—Kookmin, Shinhan, Hana, Woori, and Nonghyup—grew by 5.6 trillion won in September, lower than the 9.6 trillion won increase in August.
While the Bank of Korea has undertaken a pivot toward rate cuts, the pace is expected to be gradual. Financial risks, including high levels of household debt and rising home prices, remain. Geopolitical tensions in the Middle East and a strong U.S. labor market, as seen by the recent robust September jobs report, could complicate the BOK’s monetary policy.
“Korea is not in a position to lower interest rates by 0.5 percentage points like the Fed,” said BOK Governor Rhee Chang-yong. He explained that the rate cut decision could be “interpreted as a hawkish cut, as financial stability will remain an important factor in monetary policy.” Rhee added, “Five out of six board members see that the interest rate should be maintained at the current 3.25% within three months.”
