The Bank of Korea finally joined the global rush to ease monetary policy on Thursday, cutting its benchmark rate for the first time in more than three years to shield the economy from a global slowdown, but drew criticism for boasting that its action was "pre-emptive."
Although South Korea's export-driven economy won't be helped much by the 25 basis point rate cut to 3 percent, it could ease the burden on heavily-indebted households and help boost domestic demand which has grown more sluggishly than expected
The move came seven days after China cut its benchmark rate for the second time in a matter of weeks and as inflation dipped again to well within the bank's 2-4 percent target range.
"Today's rate decision was made in an action against the GDP gap and also to act pre-emptively. The effects of monetary policy decisions are long-term," Governor Kim Choong-soo said at a news conference after the decision.
"The central bank needed to uphold its monetary policy responsibility rather than just look on," he said.
BANK OF KOREA UNDER CRITICISM
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Only three of 26 economists in a Reuters poll had forecast a cut and the Bank of Korea has a track record of repeatedly wrong-footing markets. It again drew criticism for its inconsistency as until Thursday's split decision it had stressed rate normalisation, or increases, to combat inflation.
"I don't know why the central bank emphasised the normalisation of rates before if they were going to cut rates this time so easily," said Park Jong-yeon, a researcher at Woori Investment and Securities.
"The Bank of Korea has lost trust from the market. It's not right to say 'pre-emptive' in this situation," he added.
Kim was forced to deny that he had cut in response to political pressure from the country's president as the decision came two days after he attended a meeting with top aides to President Lee Myung-bak and other government officials.
With presidential elections due in December, there will be additional pressure to cut rates, economists and political commentators say.
A poll conducted after the rate decision showed 13 out of 18 analysts saw the central bank cutting at least once more, but they said it would then hold the rate.
"We judge today's move as prudent, helping to limit downside risks to growth through confidence and foreign exchange channels," said Young Sun Kwon, an economist at Nomura International who has consistently maintained a minority view there would be two rate cuts this year.
Prior to the decision Kwon had assigned a 40 percent probability to a cut on Thursday.
"However, we do not think that rate cuts will be enough to reverse the downturn in the Korean economy, which is largely dependent on exports."
The monetary policy committee was split on Thursday and some economists said the decision was part of a coordinated international move by central banks, although Kim denied this.
The shock move prompted a sharp jump in bond futures, with September futures on three-year treasury bonds up 0.66 points to trade at 105.75 by the close. The won finished local trade down almost 1 percent against the dollar, while Seoul shares lost more than 2 percent.
HEAVILY INDEBTED HOUSEHOLDS
Central banks from Europe to Brazil and China have lowered their interest rates over the past week to shore up their economies and buffer the global economy from the prolonged debt crisis and slump in the euro zone.
Given the Bank of Korea's inaction in the face of inflationary pressures, it does not have as much room to cut as many other central banks.
"I do not see this as the start of an aggressively monetary easing cycle similar to that of post-2008 crisis," said Connie Tse, an economist at 4CAST.
South Korea's finance ministry last month cut its growth projection for this year to 3.3 percent from the previous 3.7 percent, but it is only slightly lower than last year's 3.6 percent or a five-year average of 3.5 percent.
The Bank of Korea will release its revised economic growth forecasts for 2012 and 2013 on Friday, which are expected to be substantially lowered from its April estimates as gloomy conditions in Europe are expected to continue for some time.
Powered by exports of Hyundai cars and Samsung smartphones and a shift in its export markets towards China and away from the stricken European and U.S. economies, South Korea has weathered the global economic crisis of 2008 onwards relatively well, but for the first six months of this year, exports only rose by 0.7 pct from the same period last year, though they did turn positive in June.
And with China's stellar economic growth slowing sharply, demand for Korean exports could come under pressure.
That leaves Korean consumers to pick up the slack, but there are few signs they are able to do so.
Debt owed by households and related non-profit organisations rose 7.7 percent by the end of March from a year earlier, the slowest pace seen since the end of 2009, the Bank of Korea said last month.
Despite the slowing growth, debt owed by households and related non-profit organisations stood at 88.6 percent of rolling 1-year gross domestic product at the end of March, Thomson Reuters calculations show.
It was little changed from 89.2 percent set at the end of 2011 and compares with less than 85 percent seen before the 2008 global financial crisis, Bank of Korea data shows.