Bank of Korea Freezes Interest Rate for 4th Month

The Bank of Korea’s Monetary Policy Committee yesterday froze the benchmark interest rate at two percent.

Since cutting the rate from 5.25 percent in October last year to two percent in February, the central bank has frozen the key rate for four consecutive months.

Bank of Korea Gov. Lee Seong-tae said, “The central banks of major economies are expected to raise interest rates earlier than expected,” in explaining why Seoul chose to freeze its rate.

The financial market had expected the freeze, so the bond yield soared.

The bank apparently believes that the rapid economic slowdown resulting from last year’s global financial crisis has ended to a degree. Accordingly, experts have released a variety of prospects for interest rate policy.

○ Housing and raw material prices as significant factors

After the committee meeting, the central bank released the big picture for its monetary policy by saying, “Boosted by effective financial and monetary policies, the economy seems to have stopped contracting. For example, domestic demand has increased and manufacturing activity has improved.”

“It is also possible that economic growth will slow down again due to surging raw material prices and an economic slowdown in major economies.”

The bank also said the amount of loans taken out by households and small and medium-size enterprises have gradually increased despite stabilized price variables such as foreign exchange rates and stock prices. Fears over credit risks have not yet eased, however, and financial institutions still prefer short-term lending, it added.

Economic indicators also imply that Korea’s rapid economic slowdown has ended, but the economy has not shown clear signs of recovery. In the first quarter, real GDP increased 0.1 percent from the previous quarter but the bank said real GDP would have decreased 0.6 percent without the government’s stimulus package. For the first quarter of 2009, gross national income fell 0.2 percent from the previous quarter, decreasing for the third consecutive quarter.

Negative factors hovering over the economy include sluggish activity in major economies and soaring prices of raw materials such as oil. The domestic housing market is also a major headache for the central bank. Excessive liquidity has poured into newly built apartments and the real estate market has partly overheated.

○ Surging bond yield

On monetary policy, Gov. Lee said, “The global economy is better than the worst-case scenario that emerged late last year. Certain experts also forecast that the central banks of major economies will raise interest rates earlier than expected. If the global economy recovers and major central banks change their policies, the Bank of Korea will also change its monetary policy.”

Since the central bank seems to believe that the economy has improved, bonds were put on the market in large quantities yesterday, thus pushing up the bond yield. The yield of a five-year government bond jumped 0.19 percentage point to close at 4.97 percent and that of a three-year bond grew 0.18 percentage point to 4.22 percent, setting a new yearly high.

Nomura Securities economist Kwon Yeong-seon said, “The Bank of Korea recognized that the economy and financial market conditions have improved. It is expected to begin raising the interest rate in November at the earliest and aim for a rate of 3.5 percent by next year.”

On the other hand, others cast doubt over an interest rate hike, citing uncertain prospects for economic recovery in the second half.

Kwon Soon-woo, head of macroeconomic research at Samsung Economic Research Institute, said, “The global financial crisis is not yet over. Since the central bank will find it tough to significantly reduce market liquidity, it is expected to fine-tune its liquidity management by issuing currency stabilization bonds.”

jaeyuna@donga.com