Growth Rate at 1.5%, 2?3 Cuts Expected This Year... Key Messages from February’s Monetary Policy Meeting (Comprehensive Report 2)

This Year’s Growth Forecast for Korea Lowered to 1.5%, Heightened Concerns Over Prolonged Low Growth
Four Monetary Policy Committee Members Favor Rate Hold for Next Three Months, Emphasizing Cautious Approach
Many Variables for Additional Cuts... Attention on U.S. Economic Policy and Supplementary Budget

The shadow of low growth over the Korean economy has deepened. On February 25, the Bank of Korea sharply lowered its forecast for this year's economic growth rate to 1.5%. This is not only below last November's projection of 1.9%, but also lower than the 1.6-1.7% range anticipated during last month's interim review. Reflecting heightened concerns over prolonged low growth, the Bank of Korea's Monetary Policy Committee cut the base interest rate by 0.25 percentage points. The market interpreted this rate cut as a "hawkish cut," indicating that any additional cuts will be considered cautiously, taking into account a wide range of variables.

Lee Changyong, Governor of the Bank of Korea, is delivering opening remarks at a press conference on monetary policy direction after the Monetary Policy Committee's plenary meeting held at the Bank of Korea headquarters in Jung-gu, Seoul on February 25, 2025. Photo by Joint Press Corps

This Year’s Korean Economic Growth Forecast at 1.5%... Warning Lights for Domestic Demand and Exports

In its revised economic outlook released on this day, the Bank of Korea projected that the Korean economy will grow by only 1.5% this year. The "1.5%" figure is lower than the forecasts of the OECD (2.1%) and the IMF (2.0%), and is even more conservative than the Korea Development Institute (KDI), which recently lowered its outlook to 1.6%. For the first quarter of this year, the Bank of Korea expects the economy to grow by just 0.2% compared to the previous quarter. This is below the earlier forecast of 0.5%, due to factors such as the anticipated U.S. tariff policy, weakened sentiment amid political uncertainty, and temporary factors like weather conditions.

Previously, in November last year, the Bank of Korea lowered its growth forecast for this year from the previous (August) estimate of 2.1% to 1.9%, reflecting the strengthening of U.S. protectionist policies. In last month’s interim review, the forecast was revised down again to 1.6-1.7%. This revision reflected political uncertainty triggered by the declaration of martial law, the resulting deterioration in economic sentiment, and changes in U.S. economic policy following the election of President Trump.

At a press conference following the base rate decision, Governor Lee Changyong explained, "The reason we lowered the growth forecast further this time compared to the interim review in January is that, while domestic factors such as the martial law situation were the main reasons in January, this time, uncertainty has increased due to U.S. tariff policies following President Trump's inauguration." He added, "Specifically, in the January forecast, we assumed tariffs would be imposed on China in the second quarter and on other countries next year, but now the timing of tariff imposition is expected to be earlier than initially anticipated, and there is a higher possibility of increased tariff rates, reflecting growing uncertainty in the trade environment." He also explained that whether the reciprocal tariffs scheduled for April and the 25% tariffs on semiconductors, steel, automobiles, and pharmaceuticals will be implemented immediately or postponed has been factored into the growth rate forecast probabilistically. The base effect from the fourth quarter of last year, when the economy grew only 0.1% quarter-on-quarter, was also taken into account.

The effect of an extra budget (supplementary budget) is expected to boost the growth rate by 0.2 percentage points, assuming it is implemented on April 1. Governor Lee said, "If the supplementary budget is set at 15 to 20 trillion won, it will have the effect of raising the growth rate by 0.2 percentage points. This means this year’s forecast of 1.5% could be raised to about 1.7%." However, he cautioned that a larger-scale budget could have side effects.He further explained that the effect of fiscal policy on stimulating the economy will turn negative unless it increases further next year.

The biggest concern cited was that both domestic demand and exports, the main drivers of the Korean economy, are performing worse than expected. In terms of domestic demand, the slump in construction investment that dragged down economic growth last year is continuing, and private consumption has also been slow to recover since the declaration of martial law. Even exports, which have been the mainstay of the Korean economy, are widely expected to see slower growth this year, except for semiconductors.

The economic growth rate for next year is projected to be 1.8%, unchanged from the forecast made last November. If this projection materializes, the Korean economy will fall below or barely meet its potential growth rate (2%) for four consecutive years-2023 (1.4%), last year (2.0%), and the next two years. This suggests that it will be difficult to achieve the robust growth seen in the past. Analysts warn that unless a clear new growth engine is found amid worsening aging and low birth rates, a decline in the potential growth rate is inevitable.

Governor Lee stated that structural reform is necessary to further raise the growth rate. He said, "Personally, I think 1.8% is a decent growth rate," emphasizing, "Globally, growth is low and conditions are tough due to policies like President Trump's tariffs, so I don't think we can grow faster than the potential rate (2.0% for 2024-2026)." He continued, "There is a widespread perception that 1.8% is a crisis or a struggle because we have become too accustomed to high growth in the past, but I think we must accept this since we have not carried out structural reforms and have relied only on existing industries. If we lower the base rate and mobilize fiscal resources to achieve 1.8% growth, household debt will rise and the country will face greater difficulties."

After January's 'Cut-like Hold'... February's 'Hold-like Cut'

On this day, the Bank of Korea's Monetary Policy Committee lowered the base rate to 2.75% per annum, a 0.25 percentage point reduction from the previous 3.00%, in line with market expectations. This is the first time the base rate has fallen to the 2% range since October 2022, about two years and four months ago.

In October last year, the Monetary Policy Committee pivoted for the first time in three years and two months, lowering the base rate from 3.50% to 3.25% per annum, followed by another 0.25 percentage point cut in November. Last month, the rate was held steady due to factors such as trade policy uncertainties following President Trump's election and a sharp rise in the exchange rate amid political uncertainty after the December 3 Martial Law. This month, the committee resumed rate cuts with another 0.25 percentage point reduction.

The main reasons for this month's cut were downward pressure on the economy and concerns about a further downgrade in Korea's economic growth rate. With both domestic demand and exports, the pillars of the Korean economy, flashing warning signals, there was growing support for using a rate cut to support economic stimulus. The external variables and exchange rate pressures that led to last month's rate freeze have now stabilized to some extent, creating an environment where concerns about growth can take center stage. With additional political risks remaining limited and the "Trump uncertainty" that had fueled a strong dollar now easing, the won-dollar exchange rate has also stabilized. At the end of last year, amid severe political turmoil and strong dollar pressure, the won-dollar exchange rate surged to 1,480 won, increasing volatility. Recently, however, the rate has fallen below the 1,450 won level, thanks in part to eased concerns about tariffs under the new U.S. administration.

Household debt is also not considered to be at a dangerous level at present. While there are concerns that housing prices, which had been stable due to the lifting of land transaction permit zones, are showing signs of rebounding, this is limited to certain regions. In other areas, unsold housing units remain a problem, deepening polarization. Therefore, it is expected that the government will respond not through monetary policy but by further strengthening the total debt service ratio (DSR) regulations.

Lee Changyong, Governor of the Bank of Korea, is speaking at a press conference on the interest rate decision of the Monetary Policy Committee held at the Bank of Korea in Jung-gu, Seoul on the 25th. 2025.02.25 Photo by Joint Press Corps

Many Variables for Additional Cuts... Focus on Exchange Rate, U.S. Economic Policy, and Supplementary Budget

The market interpreted the Monetary Policy Committee's latest rate decision as a "hawkish cut," mainly due to the committee members' outlook for rates over the next three months. Four committee members supported maintaining the current rate, expressing concerns that the room for further cuts is quickly being exhausted amid high domestic and external uncertainties. They argued it would be preferable to hold rates steady for now and monitor changes in conditions. Only two members believed an additional cut should be made during this period. Although this is a conditional outlook, it suggests that the likelihood of another rate cut before May is low.

Both the relatively stable exchange rate and the U.S. trade policy variable could change rapidly at any time. Jae Kyun Ahn, a researcher at Shinhan Investment Corp., said, "Given the continued high volatility in the exchange rate due to domestic political risks and Trump administration policies, we must keep a close watch on exchange rate trends." The Trump administration's tariffs on automobiles and semiconductors, which could be announced earlier than the scheduled April 2 date, are also key variables that could determine the path of Korea's interest rates.

Following this month's cut, the timing of any additional rate reductions will depend on developments such as the decision on the supplementary budget and inflation trends. The uncertainty over the scale and timing of government stimulus measures was one of the factors behind last month's rate freeze. The Bank of Korea maintained its forecast for this year's consumer price inflation at 1.9%. While this is in line with the Bank's inflation target (2.0%), there is still room for inflation to be further affected, given that consumer prices exceeded market expectations in both December and last month, and that a strong exchange rate could be reflected in prices. Minju Kang, chief economist at ING Bank, predicted, "The Bank of Korea will closely monitor the effects of the three rate cuts since the end of last year and pay close attention to whether the pace of inflation slows."

Governor Lee emphasized, "An annual rate of 2.75% is at or above the upper end of the range, even considering the diversity of neutral rate models," indicating that the rate cut cycle will continue. However, he said the timing would be determined by considering various factors. The market consensus is that there will be two to three rate cuts this year, including the latest one. He said, "The majority opinion in the market seems to be that the rate will be cut two or three times this year, including the February cut. As we forecast a 1.5% economic growth rate in February, we internally assess our rate policy, and the market outlook is not very different from our assumptions." However, the market is increasingly expecting that, following this cut, there will be only one more cut this year, with the final rate remaining around 2.5%.

This latest rate cut by the Monetary Policy Committee has widened the interest rate gap with the United States to 1.75 percentage points. Experts predict that, as the U.S. Federal Reserve is expected to keep rates on hold for the time being while monitoring inflation and employment, the Bank of Korea will also moderate the pace of its rate cuts. Sungjin Kang, a professor of economics at Korea University, noted, "There is no sign that the U.S. will lower rates anytime soon, so the gap could widen further, and oil prices are not fully stabilized. The household debt issue is also a complex problem that must be considered. There are many factors to weigh before cutting rates further to stimulate the economy."

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