The Bank of Korea lowered the policy interest rate by a quarter of a percentage point to 2.25 percent last week. It was the first time that the central bank had cut the benchmark rate in 15 months.
The BOK’s decision to bring down the key rate to its lowest level in three years and 10 months is well timed. Most of all, it comes on the heels of the 41 trillion won fiscal stimulus package and measures to support the service sector unveiled by the government earlier this month.
With prices stabilizing and the Korean won continuing to appreciate against major currencies, the BOK was under pressure to lower the benchmark rate. But it had frozen the rate for the previous 14 months, citing problems like growing household debt.
BOK Gov. Lee Ju-yeol said the central bank lowered the key interest rate because the sinking of the Sewol ferry had suppressed domestic consumption for longer than expected and that the economy showed signs of downside risks. The central bank had already lowered the growth forecast for this year to 3.8 percent from 4.0 percent.
The central bank’s monetary policy committee also said that improvements in domestic demand, which had contracted due mainly to the Sewol ferry disaster, have been insufficient, and investment sentiments also continued to be sluggish.
The committee forecast that inflation would gradually rise over time, but that inflationary pressure would not be high for the time being.
Korea needs a catalyst for boosting its economy because, despite the continued boom in exports and current account surplus, it faces signs of deflation with consumption and facility investment in the doldrums. The surplus in the current account is more the result of increase in imports than expansion of outbound shipments.
The rate cut, although it had been widely expected, will certainly put wings on the government’s stimulus package, which includes the fiscal spending plan. More important is that the government and the central bank share views about the economic situation and that they are moving in the same direction. This will further bolster economic players’ sentiment.
Now that government’s fiscal policy pushed by the economic policy team headed by Deputy Prime Minister Choi Kyung-hwan has been complemented by the central bank’s monetary policy, the job of maximizing the effects of the double boosters ― the stimulus package and interest rate cut ― is left to Choi and his economic policymakers.
One thing that should be done urgently is to accelerate the fiscal spending the government promised under the stimulus package, so that money can flow into consumption and investment quickly.