Global Economics Tuuli McCully 1 (416) 863-2859 [email protected] October 15, 2014 South Korea-X-Press Neil Shankar 1 (416) 866-6781 [email protected] Benchmark Interest Rate Reduced in South Korea Event The Bank of Korea (BoK) lowered its benchmark interest rate by 25 basis points (bps) to 2.00% on October 15th. Significance The BoK implemented additional monetary stimulus in hopes of bolstering the struggling economic recovery amidst greater financial market volatility and its potential adverse impact on sentiment. However, the move also increases the risk of household debt reaching higher levels; partly due to this concern, the BoK will likely maintain the current monetary policy stance in the coming months. Market Reaction The South Korean won (KRW) strengthened against the US dollar (USD) following the Monetary Policy Committee’s (MPC) announcement. The statement issued by the MPC indicated that the central bank will likely pay greater attention to financial stability going forward, as well as its concern regarding the vast depreciation of the KRW vis-à-vis the USD and net sell-off of stocks by foreign investors. Accordingly, and despite the rate cut, the currency is trading at USDKRW1063 at the time of writing, 0.6% stronger on the day. We expect the won to close the year at 1060 per USD. Meanwhile, the Korean benchmark KOSPI Index remained virtually unchanged on the day; the index has slid 4.2% year-to-date. Analysis and Outlook Today’s decision takes the BoK’s base rate to the level observed during the February 2009 - November 2010 period, following the 2008 global financial crisis. The cut comes after an equivalent reduction following the monetary policy meeting in August and is aimed at placing the economy on a steadier recovery track. We expect the BoK to hold off from further monetary easing as the South Korean economy is set to strengthen in the coming months; moreover, policymakers assess that while price pressures are currently low, the upside risks to inflation outweigh downside risks. Concern over the already high levels of household debt (which reached around 85% of GDP at the end of 2013) will also serve as a deterrent to future rate cuts. BoK authorities point to gradually improving domestic consumption, steady employment expansion, and sustained export sector growth in the externally oriented economy (South Korean exports of goods and services are equivalent to 54% of GDP as of 2013) as indicators of sustainable economic growth over the medium term. Nevertheless, policymakers also assess that facilities investment remains sluggish and that sentiment among economic agents has only partially recovered. Furthermore, the authorities note that downside risks to the growth outlook remain significant. Accordingly, the BoK revised its real GDP growth forecasts downwards, and now expects the economy to expand by 3.5% in 2014 (from the earlier forecast of 3.8%) and by 3.9% in 2015 (from 4.0%). The decision to ease monetary conditions for the second time since August further complements the government’s US$40 billion stimulus package that was announced in July in an attempt to support household and business spending as well as the real estate sector. The stimulus package has successfully contributed to the recent upward trend in real estate prices in Seoul and its surrounding areas. Today’s decision was likely influenced to some extent by persistent pressure from the South Korean government to cut rates, namely from Finance Minister Choi Kyung-hwan, leading to some concerns regarding the central bank’s independence. South Korean price expansion was at a 7-month low in September. The consumer price index rose by 1.1% y/y, down from a 1.4% increase in August. The continued decline in petroleum product prices and near-zero producer price inflation will contribute to negligible upside pressure on headline inflation over the medium term. We expect inflation to remain muted in the coming months, closing the year at 1½% y/y, before accelerating slightly to around 2½ % by the end of 2015, at which point it will reach the lower boundary of the BoK’s 2½-3½% target range. South Executive Korea-X-Press Briefing isisavailable availableon onscotiabank.com scotiabank.comand andBloomberg BloombergatatSCOT SCOT October 15, 2014 Global Economics South Korea-X-Press INTERNATIONAL ECONOMICS GROUP Pablo F.G. Bréard, Head 1 (416) 862-3876 [email protected] Erika Cain 1 (416) 866-4205 [email protected] Estela Molina 1 (416) 862-3199 [email protected] Neil Shankar 1 (416) 866-6781 [email protected] Scotiabank Economics Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6253 Fax: (416) 866-2829 Email: [email protected] Rory Johnston 1 (416) 862-3908 [email protected] Tuuli McCully 1 (416) 863-2859 [email protected] This report has been prepared by Scotia Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank nor its affiliates accepts any liability whatsoever for any loss arising from any use of this report or its contents. TM Trademark of The Bank of Nova Scotia. Used under license, where applicable.