Four Rate Cuts Have Yet to Boost Growth... Only Real Estate Stimulated

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The Bank of Korea has analyzed that, despite a 1 percentage point drop in the base interest rate since the monetary policy pivot in October last year, this has not led to a boost in economic growth. Due to both domestic and external uncertainties, economic agents have postponed consumption and investment, resulting in no visible effects. On the other hand, the rate cuts have partially stimulated the real estate market and household debt, with approximately 26% of the increase in Seoul housing prices attributed to these factors.

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On the 11th, the Bank of Korea released its Monetary and Credit Policy Report, which included an analysis titled "Assessment of the Macroeconomic and Sectoral Effects of Base Rate Cuts." The report examined the lagged effects of the four rate cuts on the real economy. From October last year to May this year, the Bank of Korea lowered the base rate from 3.5% to 2.5% in four steps, totaling a 1 percentage point (100 basis points) reduction.

According to the analysis, these rate cuts have eased financial conditions and buffered the slowdown in growth, but have not yet translated into a tangible increase in growth. The Bank of Korea attributed this to heightened domestic and external uncertainties, which have lowered the interest rate sensitivity of economic agents. Using a threshold VAR (Vector Autoregression) macroeconomic model, the analysis found that, during periods of high uncertainty, the impact of rate changes on GDP, consumption, and facility investment is estimated to be only about half as strong as during periods of low uncertainty. As a result, the growth-boosting effect of rate cuts in the first half of this year was somewhat lower than the historical average.

Since June, some of the domestic and external uncertainties have eased. Considering the typical lag of two to three quarters, the growth-boosting effects of the rate cuts are expected to materialize in earnest from the second half of this year. Based on historical averages analyzed with the macroeconomic model, the cumulative 1 percentage point rate cut is estimated to raise Korea's economic growth rate by 0.27 percentage points over the coming year.

Meanwhile, the rate cuts are estimated to have raised inflation by 0.1 percentage points, a level similar to the historical average. The Bank of Korea noted that, while the effects on consumption and investment were lower than in the past due to high uncertainty, the inflationary pressure through the exchange rate channel has increased.

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The rate cuts have had some effect on raising housing prices in the Seoul metropolitan area and increasing household debt. According to an analysis using the VAR model, about 26% of the increase in Seoul apartment prices in the first half of this year was attributable to the rate cuts. The remaining 74% was estimated to result from other factors such as supply-demand dynamics, regulations, and market sentiment.

Going forward, housing prices in the metropolitan area and household debt are expected to continue to slow due to policy effects (such as the June 27 household debt measures and the September 7 supply expansion plan). However, the Bank of Korea pointed out that, since the rate of increase in Seoul housing prices remains high, there is still upward pressure from eased financial conditions and ongoing supply concerns. Therefore, it is necessary to continue monitoring whether a stable trend will be established.

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The rate cuts have directly reduced interest burdens for both households and businesses.

For households, interest burdens in the first quarter of this year were 0.25 to 0.68 percentage points lower than in the fourth quarter of 2023. By income level, the reduction was largest among high-income households, while the reduction as a percentage of income was most significant for middle- and low-income households. By age group, those in their 20s and 30s saw the largest drops in both absolute and relative terms. By debt service ratio (DSR) level, households with low or medium DSR increased their borrowing, while those with high DSR made net repayments. By age, those in their 40s expanded borrowing, mainly through mortgage loans.

For businesses, interest burdens fell by 0.27 to 0.54 percentage points compared to the second quarter of last year. The decline was more pronounced for small and medium-sized enterprises (SMEs) with shorter loan maturities than for large corporations, with little difference across industries. Borrowing increased for both large corporations and manufacturers, especially since the second half of last year, while SMEs and service sector firms shifted to net borrowing.

However, the reduction in interest burdens did not lead to increased household consumption or corporate investment. That said, since June, economic sentiment has rebounded and credit card spending has been on the rise, so the data may soon confirm an uptick in consumption.

Park Jongwoo, Deputy Governor of the Bank of Korea, stated, "We need to further examine the growth-boosting effects and financial stability impacts of the recent base rate cuts to determine the timing and pace of any additional rate reductions going forward."

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