Korea cuts rates as part of expansionary plan

Choinomics becomes political reality as Bank of Korea ignores its own assessment to deliver political rate cut.
Bank of Korea
Bank of Korea

Korea’s central bank dutifully delivered a 25bp interest-rate cut on Thursday as part of a “welcoming gift” for the new finance minister, Choi Hyung-hwan.

It is the first rate cut since May last year and reduces the base rate to 2.25%, delivering the easier monetary conditions that Choi says are necessary to boost growth. He has also promised W40.7 trillion of stimulus, including W11.7 trillion extra fiscal spending and a package of structural reforms — a big bang expansionary policy.

Bank of Korea governor Lee Ju-yeol, who is also a new appointee, seems to have struck a cooperative relationship with Choi, drawing comparisons among analysts to the relationship between Shinzo Abe and Hiroki Kuroda in Japan.

“The rise of Choinomics has apparently become a political reality,” wrote Raymond Yeung, an economist at ANZ, in a report two weeks ago.

Lee said the rate cut would revive sentiment, though analysts were sceptical about the central bank’s reasoning — and about its independence from political decisions.

“It was a nice handshake for the finance minister,” Yeung told FinanceAsia. “But it’s difficult to understand if you look at the overall tone of the bank’s economic assessment. I fully agree that sentiment has been weak, but that’s not a scenario of just the last two months — it’s been like that since the property collapse two years ago.”

Indeed, the rate cut comes at a time when key economic indicators are generally looking good. GDP growth has been above the 3% rate for the past four quarters, export growth for July was double that and the recovery seems to be on track.

However, there is one area where the central bank is doing a terrible job: hitting its inflation target of 2.5% to 3.5%. July inflation fell to 1.6% from 1.7%, but in reality nobody at the Bank of Korea is worried about a eurozone-style deflationary trap — and nobody thinks the rate cut was an attempt to avoid one.

Instead, Choi is clearly determined to break away from the country’s traditional policy of following the US Federal Reserve.

“Future MPC action will become more data-dependent,” said Yueng. “Forward guidance may also emerge as a new strategy.”

¬ Haymarket Media Limited. All rights reserved.
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