BOK ends 3 years of monetary tightening with 0.25 percentage point cut

Bank of Korea Governor Rhee Chang-yong strikes the gavel at the Monetary Policy Board meeting held at the Bank of Korea in Jung-gu, Seoul, on the 11th. (Joint Press Corps)

South Korea pivoted its monetary policy from tightening, aimed at curbing inflation, to easing in an effort to boost the sluggish economy. The Bank of Korea (BOK)’s Monetary Policy Board announced a 0.25 percentage point cut in the key interest rate on Friday, lowering the rate from 3.50 percent to 3.25 percent.

This is the first shift towards a looser monetary stance since the central bank began raising rates in August 2021 and is also the first rate cut in over four years, with the last decrease occurring in May 2020. By reducing interest rates, the BOK hopes to alleviate pressures on domestic consumption and investment, which have been struggling due to high inflation and interest rates.

The rate cut, however, raises concerns about reigniting the already unstable real estate market in the Seoul metropolitan area, as well as increasing household debt. Despite these risks, the BOK deemed it necessary to ease the strain on the economy, which has shown signs of slowing down. The decision is seen as a preemptive measure to stimulate the economy before a more pronounced downturn takes hold.

Economic growth has been underwhelming, with Korea’s real gross domestic product (GDP) shrinking by 0.2 percent in the second quarter of 2024 compared to the previous quarter. This is the first negative growth in 18 months, following a 0.5 percent contraction in the fourth quarter of 2022. Private consumption dropped by 0.2 percent, while facility investment and construction investment fell by 1.2 percent and 1.7 percent respectively.

Inflation, a primary driver of the bank’s previous tightening, has eased in recent months. The consumer price index (CPI) rose by just 1.6 percent in September 2024 compared to the same period during the previous year, the lowest rate of increase since March 2021. This has reduced concerns about runaway inflation, making the rate cut more palatable.

Another key factor in the rate cut decision was the narrowing interest rate gap between Korea and the United States. Following the U.S. Federal Reserve’s 0.50 percentage point rate cut in September, the gap between the two countries’ rates had narrowed to 1.5 percentage points. The BOK’s move to lower rates brings the gap back to 1.75 percentage points (with Korea at 3.25 percent and the U.S. at 4.75 to 5 percent), alleviating fears of a sharp rise in the won-dollar exchange rate or significant outflows of foreign capital.

The Bank of Korea’s shift follows an unprecedented period of monetary policy volatility. The central bank slashed the key interest rate from 1.25 percent to 0.50 percent in 2020, a move that was in response to the economic fallout from the Covid-19 pandemic, and then held rates steady for nearly a year and a half. However, rising inflation, household debt, and a volatile housing market pushed the bank to begin a tightening cycle in August 2021, raising the rate by a total of 3.00 percentage points over the next 17 months.

Despite maintaining a tight monetary policy for 38 months, the Bank of Korea could no longer ignore calls from the government and political circles to ease the burden on consumers and businesses. High interest rates have weighed heavily on households and small businesses, particularly vulnerable sectors, prompting calls for action to revive private consumption and investment.

One of the central bank’s concerns, however, remains the potential for rising home prices and household debt in the Seoul metropolitan area. Although real estate prices have stabilized somewhat in recent months, following a surge in the first half of 2024, Bank of Korea Governor Rhee Chang-yong warned in September that the central bank must avoid fueling a resurgence in speculative homebuying by cutting rates too aggressively.

Household loans from South Korea’s five major banks amounted to 730.97 trillion won at the end of September, up 5.6 trillion won from the previous month although the increase was smaller than the record 9.6 trillion won rise seen in August. Meanwhile, Seoul apartment prices rose 0.12 percent in the fourth week of September, down from the 0.32 percent increase recorded in mid-August.