The Bank of Korea Maintains This Year's Growth Forecast but Lowers Next Year's Outlook: "Next Year Will Also Be Difficult" (Comprehensive)

China Slowdown, US Tightening, and Rising International Oil Prices
"Economic Recovery Next Year Not Easy"

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul, on the morning of the 24th, striking the gavel. / Photo by Joint Press Corps

On the 24th, the Bank of Korea kept the base interest rate steady at 3.5% per annum for the fifth consecutive time during the Monetary Policy Committee meeting and maintained this year's real Gross Domestic Product (GDP) growth forecast at 1.4%, unchanged from the projection made in May. Although risks originating from China have spread, casting a red light on export prospects in the second half of the year for South Korea, which has a high dependence on trade with China, the impact remains limited for now. Additionally, uncertainty over further tightening by the United States has increased the need to maintain a wait-and-see stance.

The growth forecast for next year was revised downward by 0.1 percentage points to 2.2%. There are concerns that China's economic slowdown, which plays a significant role in the global economy, could spread into a global recession, potentially shaking the government's 'low in the first half, high in the second half' outlook and leading to pressure for interest rate cuts.

The Bank of Korea's Monetary Policy Committee held a meeting to decide on monetary policy direction and resolved to keep the base interest rate at 3.50% per annum. The committee had halted its rate hike cycle in February after 18 months of increases since August 2021, and this month marks the fifth consecutive freeze following last month. With the Bank of Korea's decision to hold rates steady, the gap between South Korea's base rate and that of the United States (5.25?5.50%) remains at a record high upper limit of 2.00 percentage points.

The rationale behind the Bank of Korea's decision to hold rates this month is that although inflationary pressures are easing, there are concerns about a potential rebound. Moreover, the recent emergence of risks from China is expected to impact the economy, making it necessary to maintain a cautious stance for the time being. The consumer price inflation rate in July slowed to 2.3%, but with recent rises in international oil prices and uncertainty surrounding the direction of U.S. tightening, the Bank of Korea decided to hold the base rate steady and monitor future inflation trends.

Governor Lee Chang-yong stated, "The domestic economy is gradually improving, but inflation is expected to exceed the target level for a considerable period, and policy uncertainties remain high. We will focus on price stability and maintain a tightening stance for a significant period while assessing the need for further rate hikes."

In the revised economic outlook released that day, the Bank of Korea maintained its consumer price inflation forecast at 3.5% for this year. Governor Lee Chang-yong, during a parliamentary hearing on the 22nd, said, "The consumer price inflation rate in July was 2.3%, and core inflation was 3.3%. There is a possibility that inflation will return to the 3% range in August and September, then gradually decline to below the mid-2% range by the second half of next year."

The growth forecast for this year was also maintained at 1.4%. The government had expected exports to turn positive in the second half and show an upward trend, but the effect of China's reopening has been less than anticipated, and the recovery in the semiconductor sector, a key export industry, has been delayed, pushing back the timing of economic rebound.

Kim Jeong-sik, Professor Emeritus of Economics at Yonsei University, said, "Although factors such as rapidly increasing household debt and a rising won-dollar exchange rate support rate hikes, the recent spread of risks from China's real estate sector has destabilized the economy, which appears to be the background for the rate freeze. The Bank of Korea will likely decide on further rate hikes after observing the direction of additional tightening from U.S. Federal Reserve Chair Jerome Powell's speech at the Jackson Hole symposium on the 25th (local time)."

Next Year's Growth Forecast Revised Downward by 0.1 Percentage Points to 2.2%

Bank of Korea Governor Lee Chang-yong is presiding over the Monetary Policy Committee meeting held at the Bank of Korea in Jung-gu, Seoul, on the morning of the 24th. / Photo by Joint Press Corps

While the Bank of Korea maintained this year's economic growth forecast at 1.4%, it revised next year's growth forecast downward from 2.3% to 2.2%. This reflects the assessment that the recent slowdown in China's economy is more severe than expected, and uncertainties such as additional U.S. tightening and rising international oil prices make economic recovery challenging. Since the growth rate in the first half of this year was 0.9% compared to the same period last year, achieving the Bank of Korea's forecast requires 1.7% growth in the second half, which is a difficult target considering recent export conditions and the economy.

The slowdown in China's economy is identified as the biggest problem. Kang Sam-mo, Professor of Economics at Dongguk University, pointed out, "South Korea's economy is highly dependent on trade, so the Chinese market, which accounts for the largest share of export markets, is crucial. Even if China's economy partially recovers, many believe it will not return to previous levels, which could have a significant negative impact on our economy."

Kang In-su, Professor of Economics at Sookmyung Women's University, also said, "Although China's share in exports has decreased, the absolute amount remains large, so it is not possible to offset the decline in exports to China with exports to the U.S. in the second half. Although Chinese authorities are implementing stimulus measures, their effects are not evident, and the risk of real estate company collapses is emerging, making it unlikely that China's economy will recover in the second half."

China's Economic Slowdown and U.S. Tightening... Next Year's Economy More Unstable

[Image source=Yonhap News]

The Bank of Korea and the government continue to explain that South Korea's economy will show a 'low in the first half, high in the second half' pattern, but concerns are rising that if instability in China's real estate market grows and deflation (price decline) takes hold, not only will China's export recovery be delayed, but the ripple effects could extend to domestic financial and foreign exchange markets. Since Chinese capital holds a significant share in the domestic bond market, any future capital outflow from China could impact interest rates and the stock market.

In particular, if the U.S. Federal Reserve (Fed) raises interest rates further within the year due to stronger-than-expected domestic employment and consumption, risks of capital outflows and exchange rate issues could increase. Cho Kyung-yeop, Head of Economic Research at the Korea Economic Research Institute, explained, "Although there are no signs of capital outflow yet despite the 2 percentage point gap between Korean and U.S. base rates, it is uncertain what will happen if the gap widens further. The Bank of Korea must be deeply concerned."

The Bank of Korea's decision to hold the base rate steady could backfire after Fed Chair Jerome Powell's speech at the Jackson Hole symposium on the 25th. Last August, Powell shocked global markets with hawkish remarks at Jackson Hole. If he signals further rate hikes this time, the won-dollar exchange rate could soar, and foreign investor capital could flee. This would be the worst-case scenario for the Bank of Korea. The Bank's decision to lower next year's growth forecast by 0.1 percentage points appears to reflect such economic uncertainties.

Inflation Concerns Persist... Vigilance on International Oil Price Rebound

Although consumer price inflation has recently stabilized, it is still too early to be complacent. The Bank of Korea's revised economic outlook projects consumer price inflation at 3.5% this year and 2.4% next year, unchanged from May. Governor Lee Chang-yong previously stated in the National Assembly on the 22nd, "Inflation may return to the 3% range in August and September, then gradually fall below the mid-2% range by the second half of next year," adding, "Among advanced countries, we are the only one to have brought inflation below 3%."

However, this forecast assumes that international oil and commodity prices will stabilize downward as initially expected. Major oil-producing countries such as Saudi Arabia continue production cuts to raise oil prices, pushing Brent crude, the global benchmark, into the mid-$80 range. Although concerns over China's economic slowdown have recently caused some pullback, Saudi Arabia and others are likely to continue cuts in October, leaving room for further price increases through the end of the year.

Professor Ha Jun-kyung of Hanyang University's Department of Economics explained, "The rapid decline in inflation so far has been largely due to falling international oil prices, but now the base effect is ending, and core inflation is not yet under control. If food service and service prices continue to rise in the second half, wage pressure will increase, and the rising oil price trend could also contribute to inflationary pressures."

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