BoK's pre-emptive rate cut catches markets off-guard, more easing in the pipeline

The Bank of Korea in a unanimous decision cut its policy rate by 25bp to 1.25%. The decision was made “pre-emptively” to better cope with growing downside risks to growth toward the second quarter of the year, Bank of Korea Governor Lee Ju-yeol said, citing sluggish exports, weak domestic demand and corporate restructuring that weigh on growth.

“Part of the rationale behind the cut was likely for it to serve as a pre-emptive palliative measure to offset the negative impact of restructuring on employment and therefore private consumption,” HSBC economist Joseph Incalcaterra said.

The statement noted that the board will continue to conduct monetary policy so as to ensure the growth recovery is sustained and that inflation returns to the central bank's target over the medium-term horizon but stressed that it will "pay greater attention to financial stability" in the process. The central bank has been under pressure to ease monetary policy to prop up the slowing economy as inflation slowed to 0.8 percent in May, much lower than the BoK’s annual target of 2 percent. 

Today's cut was not a complete surprise. Markets had been pricing in a cut over the short term, given pressures to growth from weak exports and the government's corporate restructuring plans. Expectations are for the BoK to cut interest rates once more within the year as growth momentum is expected to slow further in the second half with few signs of a global recovery.

The finance ministry is widely expected to lower its growth forecast of 3.1% for this year when it makes its next economic policy announcement in late June or early July. The central bank has already trimmed its annual growth estimate to 2.8% from 3% this year. The IMF recently cut its 2016 growth forecast for South Korea to 2.7 percent from 2.9 percent in April.

“As things stand, the economy is already in a fragile state and could certainly use more support. While we expect fiscal policy to take the lead in the coming months, we are not ruling out further rate cuts,” said Krystal Tan, economist at Capital Economics. 

Thursday’s 0.25 percent rate cut sent the won lower against the US dollar and three-year bond yields fell to an unprecedented 1.33 percent. USD/KRW was trading at 1155.85 at 1200 GMT.