MNI BOK WATCH: Rate To Hold At 3.5%, Policy Shift In Focus

The Bank of Korea will likely keep its policy interest rate unchanged at 3.5% at its meeting on May 25 as focus shifts to a potentially weaker economy amid sluggish exports, observers told MNI.

“The unemployment rate fell but the number of employees is falling," said Kota Hirayama, senior economist in charge of emerging economies at SMBC Nikko Securities. "Weaker exports may filter through to the labor market situation."

A person familiar with the BOK, the Korean economy and monetary policy said the central bank will likely keep the policy rate unchanged as it monitors the impact of past hikes on inflation. “Overseas demand for semiconductors remained weak, putting downward pressure on the economy," the person said. "Inflation will not strengthen, given the current weak economic conditions.” He added that semiconductor prices had not hit bottom, though this could occur in mid-2023. Demand will likely recover, but at an uncertain pace, he noted.

Hirayama said the BOK may consider a shift to more dovish monetary policy in future if the economy worsens. "Although there is the assumption that the inflation rate continues falling,” he explained. The BOK may start to ease policy as early as Q4 if core CPI falls below 4%, he added.

Some market players expect the Bank to lower the policy rate as early as Q1 2024 and the policy rate to stay at 2.5% in or after 2025. The y/y rise in headline CPI has slowed, but core CPI remains high – a troublesome factor for the BOK. The headline rate slowed to 3.7% in April from 4.2% in March, while core CPI rose 4.6% y/y, slowing from 4.8%. The Bank has paused rates at its last two meetings, following 300bp in cumulative increases since it started tightening in August 2021. (See MNI BOK WATCH: Rate Steady at 3.5%; Flags Further Hikes),

WEAK EXPORTS CONTINUE

Exports fell 14.2% y/y in April – the seventh consecutive drop – driven mainly by weaker sales of semiconductors, which fell 41% in April for a ninth consecutive decline. Exports of semiconductors to China fell 26.5% in April, an 11th straight drop, indicating that the Chinese economy remains weak following its reopening.

The Korea Development Institute, the nation’s leading think tank, lowered its GDP forecast this year to 1.5% from 1.8%, noting exports will remain weak for some time.

BOK Governor Rhee Chang-yong indicated in April the Bank will likely lower its GDP forecast from 1.6% at the May policy-setting meeting.

The International Monetary Fund’s Asia and Pacific Department Director Krishna Srinivasan said South Korean headline inflation moderated due to lower energy prices, but core inflation excluding food and energy costs has yet to fall decisively. That means the BOK must walk a narrow path, avoiding premature easing, while minimising the risk of tightening policy too much, he said.

"Taking these considerations together, the BOK has appropriately paused rate hikes in the February and April meetings, while keeping options open for further hikes depending on incoming data,” he said.