The Governor of the Bank of Korea, Lee Chang-yong, marked his third anniversary in office on the 21st of last month. With one year remaining in his four-year term, Governor Lee is now at a point where he is being asked for the 'fruits of currency policy.' In his early days in office, he led aggressive interest rate hikes to combat high inflation, but since last year, he shifted direction to interest rate cuts as concerns over weak domestic demand emerged. However, amid rapid changes in the global economy and domestic political environment, the remaining year of his tenure is expected to face even fiercer storms.
The market consensus is that the Bank of Korea will lower the base rate at least twice this year to stimulate domestic demand. However, many believe that additional rate cuts will not be implemented even if downward pressure on the economy increases due to tariffs stemming from Donald Trump. This is because Governor Lee, who has been troubled by fears of rising exchange rates and household debt throughout his term, is likely to focus more on financial stability than on growth.
◇ Consumer prices trend downward toward 2%... Household debt ratio drops for the fifth consecutive quarter
According to the Bank of Korea on the 2nd, since taking office in April 2022, Governor Lee has continued a stringent tightening stance by rapidly raising the base rate. As a result, the consumer price inflation rate, which had exceeded 6% compared to the same month the previous year, achieved the inflation stabilization target of 2.0% last August, and the ratio of household debt to gross domestic product (GDP) has also fallen from the peak of 99.3% in the third quarter of 2021 to 90.1% at the end of last year.
Based on these results, the Bank of Korea lowered the base rate by 0.25 percentage points (p) last October, ending its tightening stance for the first time in three years and two months. This decision came as global trade uncertainties increased alongside the U.S. presidential election. Since then, as consumer sentiment was dampened by the state of emergency and the Jeju Air incident, additional cuts were made in November and February this year, lowering the base rate to 2.75%.
Various evaluations have emerged regarding this move. First, the Korea Development Institute (KDI) argued that the timing of the rate cut was delayed. KDI claimed that since the core inflation rate had approached 2% from the first half of last year, the tightening stance should be relaxed, and it subsequently intensified criticism, even mentioning the 'failure to cut rates' theory. The essence of their argument was that the Bank of Korea's delay in cutting rates means that signs of recovery in domestic demand are not visible.
Conversely, there is also an argument that rates should have been raised further. An anonymous market participant said, “The Bank of Korea raised rates proactively compared to other countries, but since halting rate hikes in January 2023, the final rate level has been lower than in the U.S.,” adding, “It was a decision due to the instability of real estate project financing (PF), but that issue has not yet been resolved, and a lower rate level has led to diminished room for further cuts.” They concluded, “It would have been better to raise rates further.”
As a result, prices have maintained a stable flow in the 2% range since the end of last year, and the increase in household debt has slowed. The exchange rate, which temporarily exceeded 1,480 won due to the state of emergency, has recently shifted to a downward trend. Based on these policy outcomes, Governor Lee was selected as the 'Central Bank Governor of the Year' for the Asia-Pacific region by The Banker, a global finance magazine last year, and this year received the prestigious 'FRA Medal' awarded by the Foreign Policy Association (FPA) in the U.S.
Following the Monetary Policy Committee meeting on November 10 last year, Governor Lee reflected on the past currency policies during a press conference, stating, “I believe the process of stabilizing prices has concluded a cycle.” He noted, “We achieved the 2% inflation target faster than any other country and managed PF insolvencies and the foreign exchange market without significant issues.” Regarding the failure theory, he responded, “I hope this will be evaluated in about a year based on the economic situation and financial stability.”
◇ Triple trouble of sluggish exports, investment, and domestic demand... Expected to lower to 2.25% within the year
However, the recent developments in both domestic and international situations present greater challenges for Lee Chang-yong's administration. Signs are emerging that the global tariff war will reignite with Donald Trump's re-election, and domestic political instability, such as premature elections, is intensifying downward pressure on the economy. Exports, which have driven the South Korean economy, ended their positive streak in January this year, and corporations' capital investments are also showing a downward trend. Some predict that this year South Korea's growth rate may fall to around 0%, rather than the Bank of Korea's forecast of 1.5%.
The problem is that it is not easy for the Bank of Korea to implement bold interest rate cuts. The lifting and expansion of the land transaction permit system have caused house prices to rise again, increasing the risk of household debt growth. According to the 'National Housing Price Trend Survey for the Third Week of April (as of the 21st)' released by the Korea Real Estate Board on the 24th, Seoul apartment prices rose by 0.08% compared to the previous week, continuing an upward trend for the twelfth consecutive week. The Bank of Korea believes that the increase in household debt could accelerate from mid-March to May when the effects of the lifting of the permit system are reflected.
The exchange rate continues to be a burden. According to Seoul Foreign Exchange Brokerage, the weekly closing price of the won-dollar exchange rate on the 30th of last month was recorded at 1,421.0 won, down 16.3 won from the previous trading day. Although the exchange rate has fallen sharply from 1,484.10 won on the 9th of last month immediately after the reciprocal tariffs were imposed, it has not returned to the level below 1,400 won seen before the state of emergency.
In this context, experts predict that even if downward pressure on the economy expands, it will not be easy for the Bank of Korea to cut rates more than three times. If the Bank of Korea were to cut rates by 0.25 percentage points each time, this would mean that the base rate is unlikely to drop below 2.25% (currently 2.75%). A Bank of Korea official said, “Governor Lee is very sensitive to exchange rates and household debt,” adding, “Even if we respond to domestic demand weakness with rate cuts, comprehensive economic stimulus including exports should be pursued through fiscal policies such as supplementary budgets.”
Another Bank of Korea official stated, “While the Bank is currently in a cycle of lowering the base rate, when and how fast it will cut depends on the situation,” noting, “We cannot predict how U.S. trade policies or tariff negotiations will unfold, and issues of financial instability such as exchange rates and household debt could also arise, so the Bank will decide flexibly while monitoring economic indicators.”
Especially in the context of the presidential election, the likelihood of various fiscal expansion pledges emerging is high, so the Bank of Korea is expected to adjust the pace of rate cuts more cautiously. A market participant indicated, “In the second half of the year, we need to focus on growth, but it seems that the Bank will move based on the intensity of fiscal policy after the election,” explaining, “When fiscal policy expands, the liquidity that flows into the market must be managed through currency policy.” Another market participant predicted, “After lowering the rate to 2.25% within the year, additional cuts will not be easy.”