The Bank of Korea "Clear Effect of Base Rate Cut, Further Decline in Loan Interest Rates Expected"

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The Bank of Korea (BOK) forecasted that loan interest rates will further decline due to the effect of the base interest rate cut, and the interest repayment burden on borrowers will gradually ease.

On the 30th, the BOK announced on its website that the effect of this month's base interest rate cut will smoothly spread to the market in the future, and loan interest rates, especially for corporate loans, will further decrease.

This can also be interpreted as a rebuttal to concerns about the effectiveness of monetary policy, which arose as banks raised household loan interest rates despite the recent base rate cut by the BOK.

The BOK explained that loan interest rates had initially preemptively reflected the base rate cut too quickly, dropping to the base rate level of 3.50% in July, and that the recent temporary rise in household loan interest rates occurred during the normalization process of this phenomenon.

Choi Yong-hoon, Director of the BOK Financial Market Department, said, "At that time, market interest rates had already factored in expectations of about three base rate cuts," emphasizing, "It is a common phenomenon observed during a shift in policy stance that market interest rates move ahead of the base rate cut by preemptively reflecting monetary policy expectations."

Director Choi added, "In this base rate cut, the preemptive reflection period was considerably faster and the magnitude was quite large compared to past monetary policy stance shifts," explaining, "This is likely due to the large base rate hike of 3.00 percentage points and the long duration (20 months) at the peak (3.50%) since the second half of 2021 in this monetary policy cycle." He further noted, "The decline in global interest rates was also influenced by major central banks, including the U.S. Federal Reserve, pivoting their monetary policies earlier."

Immediately after the base rate cut earlier this month, market participants began to perceive that expectations for the degree of monetary easing were somewhat excessive, leading to limited further declines or even some increases in market interest rates, which was also reflected in loan benchmark interest rates, according to the BOK's analysis.

Additionally, the BOK explained that the increase in bank loan interest rates since August should be understood as a measure to manage loan portfolios through normalization of the spread rates. Due to intensified loan competition following the introduction of refinancing loan platforms, banks' household loan spread rates had dropped close to zero during the first half of the year, and the recent rise in loan interest rates should be seen as a return to normal levels.

The BOK predicted that although the effect of the base rate cut has been preemptively reflected in medium- to long-term market interest rates and linked loan interest rates, the preemptive reflection in short-term market interest rates, which are more closely related to the base rate, was not significant due to their nature, so loan interest rates linked to these are likely to decline further.

In fact, since the base rate cut, long-term market interest rates have fluctuated slightly, but major short-term market interest rates such as negotiable certificates of deposit (CDs) and bank bonds have fallen by nearly 10 basis points (0.1 percentage points). Therefore, it is expected that variable-rate loans indexed to these benchmark rates, particularly corporate loans, will gradually see lower interest rates.

The BOK emphasized that the easing effect on borrowers' interest repayment burdens will become increasingly evident as the preemptive reflection of the base rate in loan interest rates is combined with the effect of further declines.

The balance-based loan interest rate, which indicates borrowers' interest repayment burden, has steadily declined this year, with household loans decreasing by 0.30 percentage points and corporate loans by 0.37 percentage points through August. The reduction in interest burden is estimated at approximately KRW 2.7 trillion and KRW 4.9 trillion annually, respectively. The BOK expects this interest burden relief effect to grow as new loan interest rates fall further and existing loans are refinanced or variable-rate loan interest rate reset periods arrive.

Director Choi stated, "Since central bank interest rate policies significantly impact all economic agents through various transmission channels, the effectiveness of monetary policy should be comprehensively evaluated within a broader framework and longer timeframe rather than judging solely by the movements of indicators limited to specific periods or sectors."

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