In August, South Korea’s consumer price inflation rate slowed to 2.0%, marking the lowest level in three years and five months. The Bank of Korea noted that the country’s inflation deceleration is progressing faster than in major advanced economies. Inn fact, as of July, the inflation rate in the United States stood at 2.9%, while in the Eurozone, it was 2.2%.
During the COVID-19 pandemic, the central bank had slashed the base interest rate to 0.5%, but gradually raised it to 3.5% in Jan. 2023, maintaining a high rate to curb inflation. The soaring prices over this period significantly burdened the public, as rising costs and interest rates increased household spending, while income remained stagnant.
As a result, household savings decreased for eight straight quarters starting in the third quarter of 2022. After enduring high interest rates and inflation, the public is finally seeing some stability in prices. However, despite this improvement, the Bank of Korea’s Monetary Policy Board decided to keep the interest rate at 3.5% in August.
The reason why the Bank of Korea is hesitant to lower interest rates, even though inflation has stabilized, is the rising housing prices in the Seoul metropolitan area and the resulting increase in household debt.
To avoid a sharp decline in the real estate market when home prices were falling, the government encouraged people to buy homes by offering low-interest loans. This led to rental prices in Seoul rising for 67 weeks in a row and apartment sale prices going up for 23 weeks straight. The rate at which Seoul apartment prices have increased is now the highest in nearly six years.
Despite this, the Minister of Land, Infrastructure, and Transport underestimated the situation, claiming that prices wouldn’t continue to rise and dismissing the increases as temporary and isolated. However, when home prices started to rise sharply due to the policy loans, the S. Korean government acted too late, announcing real estate supply measures on Aug. 8 and tightening lending rules in September, which led to widespread criticism for missing the right timing.
In August, household debt at the five major banks rose by a record 9.62 trillion won ($7.1 billion), surpassing the previous peak in Nov. 2020 during the height of the real estate boom. Most of this increase—93%—came from home mortgage loans, which jumped by $6.6 billion.
To pull out of the prolonged domestic demand slump and ease the pain of high-interest rates, a rate cut is urgently needed. However, if housing prices continue to rise, it will be hard to expect a rate cut in October because lowering interest rates might even further drive up apartment prices in Seoul and the surrounding areas. It’s frustrating to see that even though the timing is right for a rate cut, the government’s misjudgment of the real estate market has made it difficult to carry out.
