Bank of Korea Holds Rate at 2.75% Amid Inflation, Won Decline

The Bank of Korea has chosen to maintain its benchmark interest rate at 2.75% despite rising domestic consumer inflation and a significant depreciation of the Korean won, which recently hit a 16-year low. This decision is aimed at stabilizing the financial system amidst escalating trade tensions and economic uncertainties, particularly those stemming from the aggressive tariff policies implemented by the Trump administration.

The central bank's decision to keep the rate unchanged was met with mixed reactions from economists. While some had anticipated a rate cut, the bank's decision to hold steady was seen as a move to maintain stability in the financial markets. The Korean won experienced fluctuations following the announcement, while the stock market saw an expansion in gains.

The recent depreciation of the won, which reached nearly 1,490 won per dollar, has exacerbated inflationary pressures due to higher import costs. March saw a 2.1% year-on-year increase in consumer prices, reversing market expectations of a continued slowdown in inflation. The central bank acknowledged that the economic slowdown has been more pronounced than expected, citing the impact of U.S. trade policies and domestic political uncertainties.

The bank's statement indicated a continued inclination towards further rate cuts in the future, although the upcoming presidential election in June adds complexity to this decision. The political landscape, with the possibility of a change in government, could influence the central bank's actions. Economists suggest that a rate cut in May is possible but may be more politically acceptable if delayed until after the election.

The central bank's future decisions will also be influenced by the volatility of the won. Earlier in the week, the currency strengthened to its highest level since November 2023 following hints from the Trump administration about a potential pause on auto tariffs. Automobiles and their components are a significant part of Korea's exports to the U.S., accounting for nearly half of the $70.8 billion in vehicle exports last year.

Economists predicting a rate cut emphasize the need to sustain economic growth amidst potential disruptions from global trade tensions. The political instability and economic downturn following the imposition of martial law by Yoon Suk-yeol in December 2023 have further weakened consumer confidence, prompting the central bank to lower its economic forecasts.

The central bank has already reduced interest rates three times since October 2024 to mitigate the impact of Trump's tariffs on consumer borrowing costs and support the economy. Korea's heavy reliance on exports, particularly to the U.S., makes it vulnerable to protectionist policies. The Trump administration initially imposed a 25% tariff on Korea under the "reciprocal tariff" system, later reducing it to 10% for a 90-day period. Korea is preparing to negotiate for a further reduction in tariffs.

The central bank's cautious monetary policy is complemented by the government's efforts to stimulate the economy through accelerated fiscal spending. A supplementary budget of 12 trillion won ($8.4 billion) has been announced, exceeding the originally planned 10 trillion won. This move aims to boost long-term economic growth, particularly in consumption, which has been sluggish.

However, the political landscape ahead of the June 3 presidential election remains uncertain, with the ruling and opposition parties yet to reach a consensus on the stimulus package. Bank of Korea Governor Lee Chang-yong is expected to address the future direction of interest rate policy during a press conference later today, providing insights into the committee's expectations for the next three months. Following the February rate cut, two out of six monetary policy committee members supported another rate cut within the next three months, while four favored maintaining the current rate.