Bank of Korea Makes Record Interest Rate Cut

The Bank of Korea yesterday slashed its key interest rate by one percentage point to three percent, the biggest cut in the country’s history.

Saying the economy is on the brink of a financial emergency, the central bank in its monthly policy committee meeting also said it is also considering directly injecting liquidity into companies by purchasing corporate bonds as part of emergency measures.

“The economy has reached the threshold of a financial emergency in which the bank’s monetary board members must come up with emergency measures,” Bank of Korea Governor Lee Seong-tae said at the meeting.

The seven-day repurchase rate was cut to three percent and annual interest on the bank’s low-rate loans fell half a percentage point to 1.75 percent.

Considering inflation this year is expected to reach 4.7 percent, the record rate cut could usher in an era of “minus real interest rates.” With inflation forecast to drop to the three-percent range in the second half of next year, the key interest rate is expected to remain lower than inflation for the time being.

The key interest rate of three percent is the lowest since 1999, when the central bank shifted its policy focus from money supply to interest rates. The previous low was 3.25 percent in November 2004.

Since the U.S.-led financial crisis began in mid-September, the Bank of Korea has cut its key interest rate by a combined 2.25 percentage points.

Yesterday’s record cut is a preemptive measure in the wake of the bleak economic outlook for next year, experts said. Most forecasts say Korea’s economy will grow two percent next year.

Direct injection of liquidity into companies is also under consideration to resolve the “liquidity bottleneck,” a situation in which banks fail to supply liquidity to cash-strapped companies.

The central bank will likely supply cash-strapped companies with short-term funds by purchasing commercial papers, or short-term promissory notes, instead of corporate bonds with maturity of more than one year. The U.S. Federal Reserve Board introduced the measure after the financial crisis broke out.

parky@donga.com