Expectations for Interest Rate Cuts Due to Novel Coronavirus... 3 Concerns of the Bank of Korea

Uncertain if Interest Rate Cuts Can Boost Consumption
Low Rates May Only Fuel Real Estate Price Increases
Burden of Low Effective Lower Bound Remains

[Asia Economy Reporter Kim Eun-byeol] As the market begins to expect a base rate cut by the Bank of Korea (BOK) due to the novel coronavirus infection (Wuhan pneumonia) situation, the BOK's dilemma is growing. It has become clear that the novel coronavirus will impact the Korean economy, but opinions differ on whether a preemptive rate cut can reduce the scale of the damage.

On the 11th, a senior official from the BOK said, "It is true that the novel coronavirus exerts downward pressure on the economy, but whether the interest rate should be lowered is a matter on which members of the Monetary Policy Committee may have different judgments," adding, "Even when hearing the same economic impact figures, subjective judgments inevitably come into play regarding the extent of the impact."

The biggest concern for the BOK is whether "a rate cut can be a solution to the damage caused by the novel coronavirus." Since the Lunar New Year holiday, when the virus began to spread in earnest, consumption has been the most affected area. A clear contraction in consumption has been confirmed in offline stores such as movie theaters, marts, and department stores. However, it is uncertain whether lowering interest rates while the virus is still spreading will increase offline consumption. Another BOK official said, "In a situation where the cause is a disease rather than economic contraction, it is uncertain whether a rate cut can stimulate offline consumption and encourage people to hold gatherings they previously avoided," adding, "Especially since people cannot double their consumption of things they avoided due to the coronavirus just because the crisis ends, there are limits to stimulating consumption through rate cuts."

The soaring real estate prices under the low-interest-rate regime are also a problem. At the first Monetary Policy Committee meeting held last month, a heated debate occurred over the relationship between the base rate cut and rising housing prices. Committee members who advocated for maintaining the rate pointed out that lowering the base rate was a factor driving up housing prices and increasing household debt. One committee member said, "There is still an expectation of general housing price increases, and concerns about a balloon effect toward non-regulated areas remain, so continuous caution is necessary from a financial stability perspective."

The National Assembly Budget Office also analyzed in its report on the "recent linkage between interest rates and housing prices" that housing prices rose when interest rates fell. Park Seung-ho, an economic analyst at the National Assembly Budget Office, said, "Housing prices did not rise solely due to interest rate factors, but it was a significant cause," adding, "Seoul apartment prices were more affected than those in other regions." In this situation, if the BOK cuts rates to mitigate the economic impact of the novel coronavirus but only ends up driving up housing prices, the criticism will likely be directed at the BOK, forcing it to be cautious.

Lastly, the fact that the base rate is already close to the effective lower bound is also a burden for the BOK. Although the BOK has officially stated that there is room for additional rate cuts, it realistically faces concerns about the effective lower bound. The effective lower bound is the lower limit at which monetary policy remains effective, and the market estimates it to be between 0.75% and 1.00%. Considering that, as a non-reserve currency country, the effective lower bound must be operated higher than that of reserve currency countries, it is difficult to lower rates easily.

Meanwhile, since the latter part of last month when the novel coronavirus began to spread, government bond yields have continued to decline. As of 10:03 a.m., the 3-year government bond yield in the Seoul bond market is trading at around 1.301%. This is a sharp drop from the 1.450% level on the 20th of last month. The 5-year government bond yield is also at about 1.412%, slightly higher than the previous day but still on a downward trend compared to 1.583% on the 20th of last month.

This content was produced with the assistance of AI translation services.