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Bank of Korea cuts policy rate in July amid growing external risks
18 July 2019Bernard Aw
The Bank of Korea lowers the Base Rate from 1.75% to 1.50%
US-China trade dispute and Japan's export restrictions impacted
Korean exports
Weaker growth momentum and mild inflation, as indicated by PMI
surveys, support case for monetary easing
The Monetary Policy Board of the Bank of Korea (BOK) voted to
cut interest rates by 25 basis points at the July meeting, an
earlier-than-expected move that caught many analysts by surprise.
Recent data showed shrinking export volumes, painting an
increasingly gloomy outlook for the trade-reliant South Korean
economy.
Cooling economic growth
Supporting economic growth has become the main motivation for
greater monetary support. The economy is losing growth momentum, as
indicated by the latest PMI surveys. The average PMI reading for
the second quarter (48.7) was the second lowest over the past
two-and-a-half years, indicating that economic growth in the three
months to June remained subdued. This is likely to be confirmed by
an advance release of second quarter GDP numbers next week, which
IHS Markit forecasts to show the rate of economic expansion to
moderating further to an annual rate of 1.4%, down from 1.6% in the
first quarter.
The BOK also expects weaker GDP growth this year. Alongside the
rate cut decision was an update to the central bank's economic
outlook. The central bank revised down its full-year growth
forecast for the economy to an annual rate of 2.2%, down from a
forecast of 2.5% in April, amid rising external headwinds.
Darkening export outlook
Deteriorating trade conditions, which were brought about by a
combination of a softening tech cycle and rising US-China trade
tensions, adversely impacted South Korean export performance. The
latest IHS Markit PMI surveys pointed to a further contraction in
new export orders in June, a trend that has been apparent for
nearly a year.
Official statistics meanwhile indicated the deepest contraction
in exports since the start of 2016 during June.
Adding to growing concerns over the deepening export malaise in
South Korea were tighter curbs on Japan's exports of chemical
materials used in smartphone displays and chips to South Korea,
which is expected to disrupt the production of Korean technology
goods. Japan has also hinted at expanding the export restrictions
to include a broader range of items.
Limited room for monetary easing
The BOK has limited room for policy manoeuvres despite a global
shift to a dovish monetary stance. Lowering interest rates further
could undermine financial stability, a concern the central bank had
consistently highlighted previously amid elevated household debt.
It is also uncertain the extent of the effectiveness of low
interest rates in aiding export growth when the external sector is
experiencing a supply shock in the form of Japanese export
restrictions.
In this respect, calls are mounting for the policy mix to
include fiscal stimulus. Indeed, BOK governor Lee Ju-yeol noted
that active fiscal policy is needed. However, a USD 5.7 billion
supplementary budget bill, brought forth in April to boost export
growth, remained stuck in legislative limbo.
Purchasing Managers' Index™ (PMI™) data are compiled by IHS Markit for more than 40 economies worldwide. The monthly data are derived from surveys of senior executives at private sector companies, and are available only via subscription. The PMI dataset features a headline number, which indicates the overall health of an economy, and sub-indices, which provide insights into other key economic drivers such as GDP, inflation, exports, capacity utilization, employment and inventories. The PMI data are used by financial and corporate professionals to better understand where economies and markets are headed, and to uncover opportunities.
