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(News Focus) BOK locked in dilemma amid worsening economic forecasts

All News 14:28 July 12, 2018

By Kim Boram

SEOUL, July 12 (Yonhap) -- South Korea's central bank earlier said with confidence that it may raise the policy rate one or two times this year on the back of clear signs of recovery in a bid to secure policy room to deal with a future economic cycle.

It hiked the rate by a quarter percentage point from a record low of 1.25 percent in November last year for the first time in more than six years, citing the steady pace of economic recovery.

The South Korean economy expanded 1.4 percent in the third quarter of last year and posted 3.1 percent growth for the whole of 2017, compared to 2.8 in 2015 and 2.9 in 2016.

With a healthy 1.0 percent gain in the January-March period led by modest private consumption and brisk exports, the Bank of Korea (BOK) actually seemed to be seeking the best timing for a second round of rate hikes some time in the second half.

BOK Gov. Lee Ju-yeol predicted that Asia's fourth-largest economy could pull off 3 percent expansion this year thanks to strong economic fundamentals and modest private consumption.

As a result, many market appraisers and global investment banks anticipated the BOK will make a move to mark up monetary policy rates once again in July.

The Bank of Korea monetary policy board holds its decision-making meeting on the key rate at its Seoul headquarters on July 12, 2018. (Yonhap)

Coming into July, however, the South Korean economy faced strong headwinds at home and abroad, making the BOK more reluctant to take the much-awaited action.

Now, the country's reserve bank finds itself confronting a dilemma, where it may have to consider raising key rates amid shaky economic conditions and growing downside risks.

Reflecting this, the latest monetary policy meeting held the base rate unchanged at 1.5 percent, the eighth straight month of the number staying put. One board member voted for a 0.25 percentage point increase, although he was clearly in the minority.

The central bank announced it will revise down the country's growth forecast by 0.1 percentage point to 2.9 percent for 2018, citing sluggish employment conditions and rising uncertainties. The growth estimate for next year was also downgraded to 2.8 percent from an earlier 2.9 percent.

It cited the country's poor job creation numbers in recent months, driven by a sluggish manufacturing industry, amid restructuring in the labor-intensive shipping and automotive sectors.

The number of newly created positions have stayed slightly above 100,000 per month over the February-June period, marking the worst job data since the 2008 global financial crisis.

The country, moreover, is saddled with household credit exceeding 1,460 trillion won (US$1.3 trillion) as of March, most of which is floating-rate home-backed mortgages. Higher borrowing costs could place heavier burdens on those who took out loans to buy houses in the midst of the government-fanned property boom a few years ago.

Inflation pressure shows no signs of rebounding, standing still at 1.5 percent for two straight months in June. It is far lower than the BOK's target inflation of 2 percent.

At the same time, the South Korean economy will be affected by the intensifying trade spat between the United States and China, which are the country's No. 1 and No. 2 trade partners.

In the face of rising tensions over the trade issues, the country saw its exports edge down 0.1 percent in June, marking the second negative change in 20 months.

Major institutions and economists revised their outlook to predict that the BOK will raise the key rate once in August or November, or even not at all this year.

"It is unclear whether economic recovery momentum is still alive, and with inflation pressure low, it may be difficult for the BOK to raise the key rate even once," Cho Young-moo, a senior economist at the LG Economic Research Institute, said in the latest report. "It is desirable to focus on South Korea's economic cycle when mapping out monetary policy."

But still there are strong calls for a rate hike, given the U.S. Federal Reserve's hawkish rate hike schedule for 2018. Last month, the Fed raised its benchmark fund rate to between 1.75 percent and 2 percent and signaled two more rate increases by the end of this year.

Many have voiced concerns that the widening rate spread between South Korea and the U.S. may cause a massive outflow of foreign investment from the South Korean market. Some 30 percent of market capitalization of the South Korean stock market is owned by non-Korean passport holders.

(News Focus) BOK locked in dilemma amid worsening economic forecasts - 2

And a higher interest rate will help the central bank secure more policy tools for any future economic downturns.

"The BOK is wary of leaving rates too low for too long and eager to create policy space for any future economic downturns," Moody's Analytics said last week.

In the Thursday meeting, Lee Il-houng, a hawkish member of the BOK monetary board, said that it is necessary to raise the key rate by a quarter percentage point.

The market anticipates that the central bank may raise the rate in its upcoming meeting in August or October.


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