BoK has room to ease further even amid a US rate hike

Fed Chair Yellen's comment in May signalling that a US rate hike was "appropriate" within this year caused renewed concern in emerging markets, including South Korea. Potential capital outflow has been a key issue for local policy makers. Uncertainty surrounding the spillover of diverging monetary policies of the developed economies has worsened these concerns among our clients. The key question is whether South Korea will pursue a dovish monetary policy amid US rate normalisation. The possibility of the Bank of Korea (BoK) easing its policy further despite an impending US rate hike, in a divergence from its historical interest rate spread with the US, says Standard Chartered.

BoK Governor Lee has repeatedly expressed concern about the tightening interest rate spread. Potential capital outflows and rising domestic household debt have been key factors preventing further rate cuts in Korea, but these are less relevant now, argues Standard Chartered. The BoK has room to ease further based on recent economic data deterioration, which calls for a boost to the economy, and the continued monetary easing trend globally.

Standard Chartered forecasts a 25bps cut in the base rate to 1.50% in June. Market expectations for a rate cut are mounting. A US rate hike could benefit the Korean economy indirectly, as it implies stronger US economic growth and thus improved trade with Korea. Capital outflow from Korea at the start of or before the rate hike cycle may weaken the Korean won (KRW) and improve exporters' price competitiveness. Analysts expect a rate cut announcement on 11 June, as the window of opportunity will shrink once the US rate hiking cycle begins and increases the risk of capital outflows from Korea.