Bank of Korea unexpectedly holds policy rate amid political turmoil

The Bank of Korea (BoK) has unexpectedly held its policy rate, with governor Rhee Chang-yong highlighting the need to further assess the country’s political situation.

The BoK’s seven-member monetary policy board decided to leave the base rate at 3%. This followed two consecutive 25 basis point cuts in October and November. One board member, Shin Sung Hwan, voted for a 25bp rate cut at today’s meeting.

The decision comes as South Korea grapples with political turmoil triggered by president Yoon Suk Yeol’s botched attempt to impose martial law on December 3. He was impeached by parliament on December 27 and arrested yesterday by anti-corruption investigators over charges of insurrection.

Rhee said at a press conference today that the board had judged that the downside risks to growth had “significantly increased” and the need for further adjustments to the base rate had risen. Board members nevertheless believed it was appropriate to keep the rate unchanged because of the need to further assess South Korea’s political situation and the economic policies of major countries, including the US under Donald Trump.

“The most significant change in the policy environment since the last November meeting has been the escalation of political risks triggered by the declaration of martial law,” Rhee said.

He added that the board had been “diagnosing the potential impact of these changes on our economy and debating how to take into account these factors in the monetary policy decision”.

Rhee said the decision also reflected a need to support the currency, “which in part has been weakening due to political reasons”. In recent weeks, the won has hit a 15-year low against the dollar.

The governor said the board would closely monitor key factors that would determine the timing and pace of any further cuts. These included domestic politics, changes in economic policies at home and abroad, and trends in inflation, household debt and the exchange rate.

Today’s decision surprised many analysts. Twenty-seven of the 34 economists polled by Reuters this month had expected the BoK to deliver a third consecutive 25bp cut, with some citing the need for the bank to support weakening growth against a backdrop of increased political risks. The seven remaining economists had expected no change to the policy rate.

In a statement today, the central bank said GDP growth for 2024 and 2025 was “highly likely” to fall below its November forecasts of 2.2% and 1.9%, respectively. It said it expected export growth to slow and domestic demand to recover at a slower pace than had previously been forecast owing to deteriorating consumer sentiments.

Inflation remained stable. Consumer price inflation rose to 1.9% year on year in December, up from 1.5% the previous month, but remained close to the bank’s 2% target.

“What appears to have prevented a cut today is the sharp fall in the won,” Gareth Leather, senior Asia economist at Capital Economics, said in a note today. However, he added there were good reasons to expect the central bank to resume its easing cycle soon as there were signs that the political crisis was having a negative impact on the economy.

He said consumer sentiment had collapsed in December and unemployment had risen sharply to 3.7% – up from 2.7% in November.

“Even if the crisis is resolved soon, GDP growth is expected to struggle as a combination of weak income growth, a downturn in the property sector and tight fiscal policy weigh on demand,” he said.

Leather said the tone of the BoK’s statement and Rhee’s press conference suggested further rate cuts were likely over the coming months. He pointed out that six of the seven board members had said they would be open to rate cuts sometime over the next three months.

Capital Economics has kept its forecast that the BoK will cut rates by 100bp in total this year.

ING senior economist Min Joo Kang said in a note that although the central bank had adopted a wait-and-see approach, it was likely to resume easing soon as the economy struggled with slowing growth.

ING expects the bank to resume rate cuts in February after confirming economic activity data for December and January.