No Better Choice
The Bank of Korea held a Monetary Policy Committee (MPC) meeting on Nov. 13 to fix the key rate at 2 percent. The central bank had lowered the rate in August and October but did not do so at this time due to the current increase in household liabilities, concerns over capital outflow, and predictions that the United States will increase its benchmark rate earlier than expected. Its negative forecast that a further key rate cut would lead to a liquidity trap at home, instead of domestic demand growth, played a part, too.
Last month, the total amount of household debt with local banks increased by 6.9 trillion won (US$6.3 billion) to record the highest monthly increment in history. Besides, housing market stability was deteriorated during the same period, contrary to the authorities’ expectations that a lower interest rate would result in more housing transactions, with the average jeonse (rental deposit) price going up and more jeonse houses turning into monthly rent houses.
The Fed, in the meantime, is forecast to raise its rate earlier than expected as the Republican Party prevails in Congress. At present, the interest rate is just 1.75 percentage points different between Korea and the U.S.
Bank of Korea Governor Lee Ju-yeol also warned immediately after last month’s MPC meeting that the interest rate cut would accelerate capital outflow. The U.S. aimed to boost its employment rate during the third quantitative easing that ended on Oct. 29. These days, its employment indices are showing some positive signs. The new employment increased for 49 months in a row from October 2010, which is comparable to the late 1980s. This could cause the Fed to hike the rate earlier.
The opinion that the won-dollar exchange rate should be raised through an interest rate cut in an attempt to cope with the weak yen appears to have subsided to some extent with the Korean and Japanese currencies moving in the same direction nowadays. Deputy Minister of Strategy and Finance Ju Hyung-hwan recently mentioned that he would try to drop the value of the won against the U.S. dollar as much as that of the yen falls. The won-dollar rate has soared since then, breaking 1,100 won per U.S. dollar on Nov. 12, and market participants are looking forward to the continuation of the high exchange rate.
“It seems that the weak yen has its own limitations in view of the possibility of a consumer price increase and cost burden,” the governor mentioned, to not connect the issue of key rate cut to the weak yen countermeasure. His remark is based on the concerns that any rate cut to deal with the depreciation of the yen, which lost 13 percent of its value in just three months, could drive more and more foreign investors out of the bond and stock markets.