Bank of Korea points to China risk, holds rate at record low

[SEOUL] The Bank of Korea held its key interest rate unchanged at a record low as it gauges the health of the economy and the impact of China's currency devaluation.

Authorities in Seoul are closely monitoring volatility in financial markets following the drop in the yuan, which the central bank said Thursday adds to uncertainties for Korea.

"It's clear that the BOK acknowledges China's move as a risk to its growth path," said Lee Sang Jae, a Seoul-based economist for Eugene Investment & Securities Co. "The chance of a rate cut is now higher with the yuan devaluation." Low borrowing costs have failed to boost economic expansion in Korea, with gross domestic product increasing just 0.3 per cent in the second quarter and exports falling every month this year. Debt is increasing faster than incomes, with bank lending to households surpassing 600 trillion won (S$710.8 billion) last month.

The central bank's decision to hold the seven-day repurchase rate at 1.5 per cent on Thursday was unanimous, and matched the forecast of all 16 analysts surveyed by Bloomberg. It follows four cuts in the past year that total a full percentage point.

Korea's won strengthened 1.4 per cent versus the dollar to 1,174.40 at 12:55 pm in Seoul. It's weakened 5 percent against the dollar since the end of June, 3.6 per cent against the Japanese yen and 1.9 per cent versus the yuan during the same period.

Governor's View "While the exchange rate should be decided on supply and demand in the market and economic fundamentals, an excessive move in one direction isn't desirable," said BOK Governor Lee Ju Yeol. "We have prepared scenarios and measures for global financial market volatility and its impact on the domestic economy." Mr Lee didn't elaborate on these.

The central bank will wait and see whether a 11.6 trillion won extra budget will help the economy, according to Park Jong Youn, a Seoul-based fixed-income analyst for NH Investment & Securities Co. Mr Park said that policy makers would also be looking for a rebound in foreign tourists after an outbreak of Middle East Respiratory Syndrome in May.

The BOK in July lowered its growth forecast for 2015 to 2.8 per cent from 3.1 per cent. Governor Lee said recent data suggests the economy is moving in line with the projection.

The economy is gradually improving as the impact of Mers recedes, the BOK said Thursday. There have been no new infections reported since early July.

Eugene Investment's Lee said China's surprise devaluation of its currency could raise concern over Korean exporters' price competitiveness.

"If the yuan continues to weaken and the won stays relatively strong, it could lead to a deterioration of Korean exports," said Mr Lee at Eugene Investment.

On the other hand, because about two-thirds of Korean shipments to its larger neighbor are intermediate goods that form building blocks for many products that China exports, the yuan devaluation could be a benefit, according to Park Chong Hoon, an economist at Standard Chartered Plc's local unit in Seoul.

Of 24 analysts surveyed by Bloomberg from July 23 to July 28, three forecast a rate cut to 1.25 per cent next quarter. The rest expected borrowing costs to remain on hold at 1.5 per cent.

BLOOMBERG