July 12, 2012 7:07 am
Plenty of voices in the market were expecting South Korea’s central bank to cut the base interest rate in the second half of this year: with export growth flagging, economists downgrading GDP forecasts, and inflation undershooting the official target, a first cut in three years seemed hard to oppose.
But few were expecting a cut quite so soon.
The Bank of Korea lowered the repo rate by 25 basis points to 3 per cent on Thursday, citing concerns about “the sluggish economies of [Korea's] major trading partners”, and a weakening domestic growth trend. It certainly wasn’t on economists’ radar: 14 of 16 surveyed beforehand by Bloomberg had predicted no change.
The swaps market showed an immediate reaction: the return on Korean won one-year non-deliverable interest rate swaps fell 30 basis points to 2.96 per cent.
Patrick Perrett-Green, head of Asian foreign-exchange and rates strategy at Citigroup said: “The market is now pricing a 50 per cent chance of a move to a 2.50 per cent repo rate in fairly short order: ie before the end of the year in our opinion”.
Other economists are also expecting at least one further rate cut: Young Sun Kwon at Nomura says the Bank will cut to 2.75 per cent in October, although he thinks it will then leave the rate unchanged for at least a year. Glenn Levine, at Moody’s Analytics, reckons the Bank will get the second cut out of the way in August.
Yet it is unclear how much domestic monetary policy can do to boost growth: with a relatively small domestic market, South Korea’s economy is geared heavily towards exports, and demand from major markets such as China and the EU has been flagging this year. While the won fell 0.7 per cent against the dollar on Thursday, the impact of limited monetary easing on the currency can hardly be a panacea in these circumstances.
Moreover, bank lending rates to consumers and businesses have become decoupled from the base rate, so this cut will do little to boost the availability of credit, argues Ronald Man, an economist at HSBC.
Equities investors, in any case, were underwhelmed by the announcement. The Kospi index was down for the fifth successive day at lunchtime, shedding 1.1 per cent.