Flash Notes-South Korea: BoK Brings Interest Rate To Fresh Record Low

Bank of Korea (BoK) cut its benchmark base rate by 25 bps to fresh record low at 1.50% this morning. 11 out of 18polled in the Bloomberg survey had expected the rate cut. BoK Governor Lee Ju-yeol said that one committee memberhas voted to hold interest rate today. Clearly, the downturn in sentiment with the outbreak of Middle East respiratorysyndrome (MERS) cases in South Korea was the key reason behind the rate cut today.

    The BoK said that “the downside risks to the domestic growth path forecast in April have expanded, owing mostly to thesluggishness of exports and to the impacts of the MERS outbreak.” South Korea’s exports contracted for the 5th straightmonth in May, by a sharper -10.9% y/y compared to -8.0% y/y in April. Meanwhile, inflation has remained low at 0.5%y/y in May after having eased to its 16-year low of 0.4% y/y in April. The central bank expects inflation to “continue at alow level, due mainly to the effects of the low oil prices.”. Although the near-term growth concerns have overshadowed that of the high household debt, the BoK maintainedcaution, highlighting again that “bank household lending has sustained a trend of increase at a level substantiallyexceeding that of recent years, led by mortgage loans.”. Going forward, the rate decisions will be highly data-dependent. With the US Fed expected to begin rate normalizationin the second half of the year and as South Korea’s interest rate is already at record low, further rate cuts will have tobe driven by further sharp deterioration in growth outlook. As such, we expect the base rate to be kept at 1.50% forthe rest of this year.

    BoK Governor Lee said that the rate cut is expected to have limited effect on KRW. USD/KRW rose to a session high of1,114.80 from Wednesday close of 1,108.00, before giving up the gains to trade lower. JPY/KRW has rebounded to around9.0 from its 7-year low of 8.8458 last Friday. We expect USD/KRW to be on an upward trajectory in the coming monthsin anticipation of US Fed interest rate normalization but the strong current account surplus in South Korea is expectedto moderate the up-move. Our end-3Q15 and end-4Q15 targets for USD/KRW are at 1,150 and 1,160 respectively.