The author is an analyst of NH Investment & Securities. He can be reached at firstname.lastname@example.org. -- Ed.
The sharp rise in the number of confirmed Covid-19 cases in Korea last week is likely to prompt a response from the BOK. We expect daily average export growth to turn negative, supporting the case for a rate cut. Specifically, we now forecast a rate cut at the upcoming February MPC meeting.
Rate cut prediction changed from April to February
We previously predicted that a BOK rate cut would come in April, when the effectiveness of the government’s real estate policies could be confirmed and calls for a FF rate cut were likely to mount. The main reasons for our April prediction were that: 1) high-base effect from the 4Q19 GDP growth and the impact of Covid-19 would significantly deter 1Q20 GDP growth; and 2) the government’s new real estate measures need time to take effect. However, last week the number of confirmed Covid-19 cases surged in Korea (from 28 cases on Feb 14 to 556 cases on Feb 23), causing us to adjust our prediction to February. Of note, even Governor Lee Ju-yeol, who previously rejected the possibility of a February rate cut, will have to take note of the speedy spread of Covid-19.
Economic indicators also provide justification for a rate cut. Based on data through Feb 20, export growth for the month is expected to turn positive for the first time in 15 months, but daily average export growth is likely to recede back into negative territory. In addition, the effect of the government’s concentrated 1Q20 fiscal spending is being eroded by Covid-19. Given that this could lead to a shortage of government funds in the future, we believe there is significant downside risk to this year’s economic outlook.
In the end, even if the base rate is frozen, the timing of a cut will simply be delayed to April, and the possibility of a rebound in yields is limited. The reason for the sharp rise in yields despite two rate cut minority opinions at the January MPC is not because of a rate freeze, but because the economic outlook of Governor Lee and the MPC policy statement turned favorable. However, the upcoming meeting will likely focus on the growing downside risks facing the economy due to Covid-19. Considering a 1% benchmark rate, flattening pressure is likely to outweigh in terms of the yield curve.
Rising expectations for FF rate cut
Last week, US Markit PMI for February dropped below forecasts for both the manufacturing (50.8) and service (49.4) sectors, with the latter sliding sharply below the benchmark (50). The impact of Covid-19 should be relatively limited in the US due to its low dependence on international trade, but PMI indicators suggest that there may be some negative effects.
Key Fed members, including Vice Chair Clarida, took a cautious stance towards further cuts last week. However, the GDP gap projection is only 0.1%p according to December’s dot-plot. We maintain our view that calls for a FF rate cut will increase in the face of a liquidity reduction.