The Bank of Korea's Monetary Policy Committee has loosened the reins on interest rate cuts and has begun to slow down the pace. The need for a rate cut has grown due to the risk of economic slowdown caused by the United States' aggressive tariff policy, but the sharp fluctuations in the won-dollar exchange rate and financial instability due to increased domestic and external uncertainties have held it back. These conditions have added uncertainty to the Bank's outlook, keeping the Monetary Policy Committee in a wait-and-see stance.
However, at the same time, the Bank of Korea made it clear that it has entered a cycle of interest rate cuts, showing a dovish tendency. All members of the Monetary Policy Committee have kept the possibility of a rate cut open within three months, and Governor Lee Chang-yong has also mentioned that the rate could be cut more than twice this year. The market expects the interest rate to be lowered at the Monetary Policy Committee meeting in May, when the revised economic outlook will be announced.
◇ Interest rate held at 2.75%… “Uncertainties in exchange rate and outlook expanded”
The Bank of Korea's Monetary Policy Committee decided to freeze the base rate at 2.75% per annum during its regular meeting held on the 17th. All five members, except Commissioner Shin Seong-hwan, who proposed a 0.25 percentage point (p) cut, agreed with this decision. Thus, the trend of rate cuts resumed in February is temporarily paused. The Bank maintained the base rate at 3.50% for 1 year and 7 months from February 2023 until it reduced the rate to 3.25% in October and then lowered it twice more in November and February to bring it down to the 2% range.
The market atmosphere suggests that this freeze was somewhat anticipated. A survey conducted by the Korea Financial Investment Association from April 4 to 9 among 100 bondholding and managing personnel found that 88% expected an interest rate freeze. This is an increase of 43 percentage points (p) compared to the previous survey in February. The remaining 12% expected a rate cut.
The key variable in this decision was the won-dollar exchange rate. After the U.S. imposed reciprocal tariffs on the 9th, the won-dollar exchange rate skyrocketed to 1,487.60 won, but dropped sharply to 1,446.0 won the next day when a 90-day grace period was announced. The fluctuation range of the exchange rate over the past week reached 67.6 won, marking the highest level since the trading hours for the foreign exchange market were extended to 2 a.m. last July. Even after that, the exchange rate increased its volatility before falling to the 1,410 won range ahead of that day’s Monetary Policy Committee meeting.
The deepening external uncertainties have also bolstered the cautious stance regarding the Bank's economic outlook. In the revised economic outlook issued in February, the Bank had projected the country's gross domestic product (GDP) growth rate for this year to be 1.5%. However, subsequent events, including the forest fire in North Gyeongsang Province and the U.S. reciprocal tariffs, have necessitated a revision of this outlook. In a report released that day, the Bank indicated that the growth rate could fall below 1.5% and even mentioned a possibility of negative growth in the first quarter.
Governor Lee Chang-yong explained at a press briefing held right after the Monetary Policy Committee that "the change in U.S. tariff policy is too drastic, and the possibility of future negotiations remains uncertain, making it difficult to ascertain how to define the reference point of the forecast." He added, "To put it metaphorically, it feels like entering a dark tunnel suddenly."
However, the possibility of additional cuts in the future remains wide open. That day, all six Monetary Policy Committee members, excluding the Governor, agreed that the possibility of lowering the base rate below 2.75% within three months should be kept open. Governor Lee explained, "The Monetary Policy Committee (members) judged that we must keep the possibility of a cut open to respond appropriately while observing the situation in the financial and foreign exchange markets, given that our growth rate forecast is very likely to decrease in May."
In addition, the Governor hinted at the possibility of further cuts more than twice this year. He stated, "The market expects that there will be two more rate cuts this year," and mentioned, "The additional cut possibilities will depend on how much the growth rate decreases in the May economic outlook." Earlier, in the press briefing following the interest rate cut in February, he had also indicated that the base rate could be cut one to two more times this year.
◇ The likelihood of a rate cut in the May Monetary Policy Committee is high… 25 basis points likely
The market is focusing on the fact that the Monetary Policy Committee raised the possibility of negative growth in the first quarter that day. The projected economic growth rate for the first quarter this year, made in November last year, was 0.5%, but this figure was lowered to 0.2% in February. The Bank stated that "temporary factors such as large forest fires, construction stoppages at some construction sites, and demand deferral for high-performance semiconductors coincided," adding that "a slight negative growth cannot be ruled out."
There is an analysis suggesting that the annual growth rate expectations should also be lowered due to the first quarter results falling short of expectations. Previously, the Bank had presented a 1.5% growth rate for this year. Jo Yong-goo, a researcher at Shinyoung Securities, stated, "This Monetary Policy Committee meeting suggests that the downward adjustment of the economic growth rate forecast could be substantial," and added, "It seems we may have to lower the expected annual economic growth rate to the low 1% range."
Mijin Heo, a researcher at Mirae Asset Securities, stated, "The growth rate outlook the Bank will announce in May will likely be below the 1.4% projected in the pessimistic tariff scenario presented in February." The Bank had previously set a ‘pessimistic scenario’ in which the U.S. raises tariffs on major trade deficit countries, including China, by the end of this year, and other countries respond with aggressive retaliatory tariffs.
Currently, the argument for a 25 basis point rate cut in May is prevailing. Externally, the trade war initiated by the U.S. complicates forecasts, and internally, the formulation of a supplementary budget also poses uncertainties, but it is clear that the growth rate will worsen. In a press briefing held right after the Monetary Policy Committee meeting, the Governor hinted at the magnitude of the rate cut.
The Governor stated, "Some people believe that if we lower the expected economic growth rate, we should raise it through stimulus measures, and I hope there are reasonable expectations regarding that." This can be interpreted as indicating that the Bank will not resort to excessive monetary policy even if the actual economic growth rate falls short of expectations. The Governor added, "We see the potential growth rate around 2%, and if we raise the difference between the actual economic growth rate and the potential with stimulus measures, there might be manageable consequences for a year, but after that, there will be tremendous side effects."
Yoon Yeosam, a researcher at Meritz Securities, remarked, "I highly assess the progress in the Trump tariff negotiations and the possibility of additional supplementary budgets," predicting that the Bank will cut the base rate by 25 basis points in May, lowering it to 2.25% by the end of the year. Likewise, Gong Dong-rak, a researcher at Daishin Securities, noted, "The monetary authorities' vigilance regarding the downside risks to growth and heightened external uncertainties remains valid," adding that further base rate cuts are possible, with May being a likely timeframe.
Meanwhile, after the interest rate decision by the Monetary Policy Committee, government bond yields rose across the board. In the Seoul bond market, the yield on three-year government bonds recorded 2.428%, up 3.4 basis points from the previous trading day. The yields on five-year and ten-year bonds also closed at 2.483% and 2.645%, increased by 0.2 basis points and 1.6 basis points, respectively. The won showed strength. The closing price of the won-dollar exchange rate weekly transaction (as of 3:30 p.m.) decreased by 7.8 won to finish at 1,418.9 won.