Flash Notes-South Korea: BoK Holding Back Further Monetary Easing

The Bank of Korea (BoK) kept its Base Rate unchanged at 2.00% for the third consecutive month today. Market was splitin its expectation ahead of the rate announcement amid low inflation and weak growth prospects.

    Headline inflation has dropped to 0.8% y/y in December, its lowest since July 1999. This prompted calls for further interestrate cut even as the base rate is already at a record low of 2.00%, similar to its lowest during the Global Financial Crisis.

    In the monetary policy statement, the BoK said that “the domestic economy will show a modest trend of recovery goingforward, but that the negative output gap will persist for a considerable time”. Inflation is expected to show gradualincrease from 2H15, dragged down by the low oil prices.

    BoK Governor Lee Ju Yeol attributed the low inflation to supply factors, predominantly due to the plunge in oil priceswhich would then render the monetary policy ineffective to tackle the low inflation. He believes that as a major oilimporter, South Korea will be able to reap benefits from disinflation from the oil price decline. Governor Lee alsohighlighted the high household debt as one of the “fragile spots” in the economy and we expect further rate cuts tosupport more debt build-up. The comments today are clear indications of BoK’s preference to maintain steady interestrate. Our base scenario is for the Base Rate to be maintained at 2.00% in the first half. Incoming data remains crucial asextended weakness in the economy will renew rate cut pressure.

    Following the monetary policy meeting, the BoK announced its revised growth and inflation forecasts for 2015. Thecentral bank has trimmed its headline inflation forecast for this year to 1.9% from a previous estimate of 2.4% and 2015GDP growth forecast to 3.4% from 3.9%.

    USD/KRW eased to 1,083.25 from a session high of 1,087.35 following the rate announcement, compared to the closeof 1,082.35 on Wednesday. The pair has turned lower since mid-December in risk aversion trade that weighed on USD/JPY. We expect JPY to continue to underpin USD/KRW while further expectation of monetary easing in South Korea canbe expected to lead to further upside in USD/KRW, especially as US Fed is embarking on its interest rate normalisation.

    On the back of broad USD strength and expectation of JPY weakness, we maintain our forecast for USD/KRW at 1,140by end-1Q15 and 1,150 by end-2Q15.