Bank of Korea Eyes First Policy Pivot in Years on Signs of Cooling Property

Sam Kim
5 min read
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(Bloomberg) -- The Bank of Korea is expected this week to conduct a long-awaited policy pivot, joining global peers in embarking on an easing cycle after the housing market showed signs of cooling and inflation eased below its target.

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Twenty of 22 economists surveyed by Bloomberg forecast the central bank will cut its benchmark interest rate by a quarter-percentage-point to 3.25% when the board sets policy on Friday. It would be the first shift of policy course since the BOK raised its rate from a record low 0.5% in August 2021 to exit from pandemic-era stimulus.

The economy has largely kept expanding since then and is on course this year to post growth of around 2.4% on the back of an export rally led by semiconductors. But those figures may be flattering.

Looking under the hood of the economy, spending by households has been almost stagnant over the last couple of years. While exports typically contribute more to South Korea’s growth than domestic consumption, the economy has relied far more on above-trend shipments abroad in the last couple of years than previously.

Once overseas demand starts to cool, the economy may start to look a lot less robust as it tries to lean on that domestic demand for momentum. Spending by households in the second quarter fell 0.3% from the previous three months.

On top of that credit risks continue to cloud the economic outlook, putting pressure on the BOK to loosen its policy settings. The Federal Reserve’s half-percentage point cut last month narrowed the gap between the countries’ respective interest rates, creating scope for the BOK to ease by half that amount without putting undue weakening pressure on the currency.

“A rate cut would provide a much-needed boost to the economy,” said Chong Hoon Park, a Standard Chartered Bank Korea economist. “Decisive monetary policy shifts in the US and China, along with an appreciating Korean won versus the US dollar, provide the BOK incentives to cut rates.”

Until now the BOK has delayed easing policy on concern that an early cut might spur an increase in household debt and threaten financial stability. Signs of overheating in the housing market in Seoul helped stoke those worries, giving authorities an incentive to extend their holding pattern even as consumer inflation stayed on a downward trajectory that eventually took it well below the bank’s 2% target last month.

Several months ago, government officials stepped in with measures to rein in housing prices, pledging a greater supply of homes and tightening lending regulations. In September, apartment purchases in Seoul as well as prices declined for a second month, suggesting the steps may be helping to cool the market’s momentum.

If the BOK does indeed lower rates on Friday, authorities are likely to accompany the move with words of caution. Home prices in the capital remain elevated, and South Korea’s ratio of household debt to economic size is among the highest in the developed world.

“Given still heightened caution around the local housing market, we expect a hawkish cut this time,” said Kathleen Oh, an economist at Morgan Stanley Asia Limited. “Guidance may be divided and the tone may sound cautious, but indeed a long-awaited cut is likely to come.”

Two BOK board members have made recent remarks telegraphing a potential cut. Board member Shin Sung Hwan said last month that while the economy has grown faster than initially projected, retail activity is stagnant, backing the case for a cut even without waiting for property markets to show definite signs of cooling.

Another member, Chang Yongsung, flagged expectations that government measures aimed at reining in housing prices would gradually take effect.

Governor Rhee Chang-yong has refrained from commenting on the direction of policy in public. He has instead characterized the extension of the record-long holding pattern as an opportunity to sound the alarm over excessive zeal for residential properties in Seoul.

A combination of other factors is helping to fuel appetite for prime real estate, including jeonse loans, a unique practice through which tenants pay about half of the value of a property up front as a deposit in lieu of rent. They get their money back when their lease term ends, and property owners meantime have cash to invest in the real estate market.

Rhee has cited an unusually strong education zeal among Seoul residents for exacerbating “a vicious cycle” that gave homes in Seoul’s ritzy Gangnam district a “myth of invincibility.”

Gangnam, a collection of districts in the south of Seoul, is home to multi-million-dollar apartments, an enclave of luxury shops and a cluster of cram schools that can help students attain placement at the nation’s top universities. For aspiring families in Seoul, securing the best possible education for their kids is a key requirement.

The supply and demand dynamics in the real estate market may ensure that the BOK takes a slow approach to any further rate cuts after it makes its first move.

Housing prices may continue to rise after credit risks discouraged developers from commencing projects during the tightening cycle, leading to a shortage of homes, according to the Korea Housing Institute, a research outfit.

“As we believe the housing market will continue to constrain the BOK’s policy reaction function, we expect the policy rate to remain in the upper range of the neutral rate estimate,” Jeong Woo Park, an economist at Nomura Holdings, said in a note.

The neutral rate is a level that neither stimulates nor restricts economic growth. Park’s comment suggests that even if the BOK does cut rates on Friday, as expected, it will still look to keep borrowing costs on the restrictive side for now.

--With assistance from Tomoko Sato.

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