Bank of Korea eyes rate cut after US Fed's historic pivot

Following the US Federal Reserve's historic half-point rate cut, expectations are rising that South Korea may follow suit, while closely monitoring its overheated real estate market and soaring household debt.

On Wednesday, following a two-day Federal Open Market Committee meeting, the Fed cut its benchmark rate by 50 basis points, marking its first reduction in over four years since the COVID-19 pandemic outbreak in 2020 and the first half-point cut since the 2008 global financial crisis. The federal funds rate now stands at a range of 4.75 percent to 5 percent.

In the latest economic forecasts, Fed officials indicated more rate cuts by year's end by up to another half a point.

Just as in the US, the Fed’s decision triggered increased volatility in the Korean market. The benchmark Kospi opened 0.75 percent higher at 2,594.67 and closed at 2,580.8, seeing sharp swings throughout the day, driven by a massive selloff from foreign investors who offloaded nearly 1.2 trillion won ($902 million) in Kospi.

The Korean won also weakened against the dollar, falling 0.45 percent to 1,326 won from the previous trading day last Friday.

While the Fed's pivot increases the likelihood of a rate cut by the Bank of Korea, the timing and pace remain uncertain amid persistent global risks and domestic financial instability.

The government and ruling party have urged the BOK to reduce rates, pointing to weak domestic demand and stable inflation. August's consumer price index growth of 2.0 percent was the lowest since March 2021.

However, the surge in household debt, driven by an overheated property market, remains a significant concern. Household loans from banks rose by a record 8.2 trillion won in August and continued to climb. As of Sept. 12, mortgage balances at the five major banks had increased by 2.18 trillion won since the end of August, reaching 570.8 trillion won.

Local financial regulators have been cautious about hasty rate cuts that could worsen household debt.

After the bank decided to keep the base rate unchanged last month, BOK Gov. Rhee Chang-yong acknowledged that prices have stabilized enough to consider rate cuts, yet cautioned, "The BOK must avoid the mistake of rapidly lowering interest rates or excessively increasing liquidity, as this could further drive up real estate prices."

Finance Minister Choi Sang-mok also stressed the need for stricter regulation of household debt during a meeting with top financial officials Thursday, stating, "If the housing market overheats or household debt rises rapidly, we will implement additional management measures decisively and promptly."

Market watchers observed that while the likelihood of a rate cut by the central bank has increased, it was not certain.

"A rate cut by the BOK in October seems increasingly likely, given the Fed's 50 basis point cut," said Kim Ji-man, senior analyst at Samsung Securities. "However, concerns about financial stability leave uncertainty about how quickly rates will be cut."

Similarly, Shinhan Securities economist Ha Keon-hyeong observed, "The Fed's rate cut and the beginning of a rate-cutting cycle have heightened expectations for an October cut by the BOK," adding that the main concern now is the pace at which household debt is increasing.

Ha highlighted that the weekly rise in mortgage loans, which was 900 billion won in the first week of September and 1.3 trillion won in the second week, needs to slow significantly. "If mortgage increases fall below 1 trillion won per week over the next three weeks, we might see a rate cut by the BOK at the Oct. 25 monetary policy meeting," Ha said.

If a rate cut does not occur next month due to persistent debt concerns, November might be the last opportunity for the BOK to make a policy shift this year.