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Bank of Korea’s Bottom Line on Interest Rates Is Now In Question

Jiyeun Lee
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Bank of Korea’s Bottom Line on Interest Rates Is Now In Question

(Bloomberg) -- How low can the Bank of Korea go? Will it join the club of central banks with interest rates at or very near zero?

With the BOK looking increasingly likely to lower its benchmark interest rate again in response to a deteriorating economy and global outlook, these are some of the questions economists are asking. The rate is already sitting at 1.5%, only a quarter percentage point above a record low.

Economists have judged 1% to be the BOK’s “effective lower bound,” or the point at which lower rates would be no longer effective. But the BOK and Governor Lee Ju-yeol have never specified a level, and many BOK watchers have started to question whether 1% is actually the floor.

“If the South Korean economy faces an imminent recession risk, I doubt the BOK would insist on sticking to 1% -- rates can go lower,” said Oh Suktae of SG Securities in Seoul, a unit of Societe Generale. Oh wrote a report last month that made the case for rates close to zero.

The limits of interest rate policy are coming into focus worldwide as the global economy slows, given that many benchmark rates remain well below long-term norms. Bank of England Governor Mark Carney recently said the effective lower bound for the U.K. is a little above 0% -- not far away from the BOE’s current policy rate of 0.75%.

The Reserve Bank of Australia’s Philip Lowe said he sees the RBA’s limit close to the levels reached by peers such as Canada and the U.S. after the global financial crisis: around 0.25-0.5%. The RBA’s benchmark is now at 1%.

As a country without a major global currency, the effective lower bound for Korea is higher than for those nations with a major currency, Lee said after holding rates last month. With the benchmark rate at 1.5%, the central bank does have some policy room but less so than before, and cutting rates below the lower bound requires caution, Lee said.

One key reason analysts now see a lower limit for the Korean benchmark is slowing inflation. With inflation at a record-low zero in August, the real interest rate -- the difference between the benchmark rate and headline inflation -- now stands at 1.5%, the highest since 2014.

Considering the decline in the economy’s potential growth rate and inflation since the previous rate-cut cycle, the lower bound now likely stands at 0.75%, according to Yoon Yeo-sam, a fixed-income analyst at Meritz Securities in Seoul.

The BOK in July said the potential growth rate is now 2.5%-2.6%, down from 2.8%-2.9%. The economy is expected to grow about 2% this year, the least since the global financial crisis.

Slow Going

Even if the lower bound has fallen, don’t expect to see rates at zero anytime soon. The BOK is also concerned about record household debt, and Lee has expressed some doubt about how effective rate cuts will be under the circumstances.

In an Aug. 1-7 Bloomberg survey, the lowest projection for BOK rates through end-2020 was 1%. SocGen’s Oh and Meritz’s Yoon shared that view, although both said rates could go lower if the economy heads toward a recession.

Bank of America Merrill Lynch stands out, last week lowering its forecast to 0.75% in the third quarter of 2020.

Governor Lee hasn’t offered a clear definition of the “effective lower bound,” and it’s not the time to defend any such threshold, economists including Kathleen Oh wrote in a Sept. 4 report. “We believe that more global pain demands a policy obligation to counter risks during this time of ‘more war causing more pain.’”

To contact the reporter on this story: Jiyeun Lee in Hong Kong at jlee1029@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Henry Hoenig, Paul Jackson

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