The U.S. Federal Reserve lowered interest rates by a jumbo half percentage point, ending more than two years of monetary tightening. The central bank has also signaled further rate cuts within the year. Since March 2022, the Fed has aggressively raised rates to curb inflation. Now that inflation is closer to the central bank’s 2% target, the Fed has decided to pivot. The European Central Bank (ECB) has already cut rates twice, and central banks in the U.K., Canada, Switzerland, Sweden, and New Zealand have also kicked off their monetary easing cycles.
The pivot comes in response to inflation subsiding over the past months, giving central banks room to stimulate economic activity by lowering rates. U.S. consumer price inflation, which had once surged to 9.1%, is now at 2.5%, the lowest in three and a half years. While inflation is cooling, the labor market showed signs of slowing down in July. The Fed’s rate cut suggests it has shifted its focus to protecting jobs and boosting the economy.
South Korea’s economy faces a similar situation. The country’s inflation problem is now under control, as consumer price inflation eased to 2% in August. But domestic demand has been sluggish. The monthly surplus of Korean households, a measure of financial leeway, has declined for eight consecutive quarters. It is high time for Korea to consider monetary easing to boost the economy.
But soaring home prices are a major obstacle. Apartment prices in Seoul have been rising for 23 consecutive weeks. Prices of “jeonse,” Korea’s distinctive housing lease system in which tenants pay a large lump sum deposit to live in a home for several years, have also increased for 67 consecutive weeks. Household lending surged to an all-time high in August.
The government initially underestimated the problem, believing prices would not continue rising. Then, it implemented measures such as easing real estate regulations, which inadvertently fueled price expectations. The country finds itself in a dilemma: the time has come to lower interest rates, but lowering rates risks further inflating the housing bubble.
This explains the Bank of Korea’s cautious stance on rate cuts. BOK Governor Rhee Chang-yong has said the central bank will base its interest rate decisions on “domestic factors” rather than following the Fed. Hopefully, the BOK and the government will work closely together to respond to the global trend of rate cuts.
