Will the Bank of Korea Join the Global Easing Campaign?

After passing on interest rate cuts in the last two months despite mounting evidence of a deteriorating economy, the Bank of Korea (BoK) will likely move to ease monetary policy when it meets on Thursday to bolster an economy that’s expected to grow at the slowest pace since 2008.

Korean won notes
Mark Harwood | Stone | Getty Images
Korean won notes

The central bank has held off on further monetary stimulus since July—when it surprised markets by trimming its policy rate by 25 basis points to 3 percent—saying it wants to monitor the effects of the previous cut and the events of the global economy.

However, recent indicators show that export-dependent Korea has lost momentum more rapidly than expected as global demand slumped.

Last week, the HSBC/Markit purchasing managers' index (PMI) on South Korea's manufacturing sector fell to a 43-month low of 45.71, marking the fourth consecutive month of contracting activity. The country's top mortgage lender also released data last Tuesday that showed real estate prices declining for a third consecutive month in September, marking the worst sequential decline since early 2009.

This batch of weak data will put pressure on the BoK to slash rates, economists say. Expectations of easing have also heightened after the central bank itself said last week in a report that it will “manage monetary policy for economic growth,” indicating a shift from targeting inflation, running at 2 percent in September.

“While the Bank of Korea is by no means under any obligation to fulfill market expectations, there are few reasons for it to surprise markets again, given current economic conditions,” Ronald Man, economist with HSBC in Hong Kong, said in a report published on Monday. “It’s not easy to get out of the mud by yourself…Without help from policymakers, downside risks to growth will likely mount further.”

Economists, including HSBC’s Man, who were polled by Reuters last month, expected the BoK to slash rates by 25 basis points on Thursday. Policy easing has become “necessary,” according to Barclays’ Economist Joey Chew, in light of weaker growth expected for the rest of the year.

In fact, she expects the BoK to revise downwards its forecast for 2012 GDP growth from the current 3 percent. Asia’s fourth-largest economy is expected to grow under 3 percent this year by economists, logging its slowest rate in 4 years, after expanding 3.63 percent in 2011 and 6.32 percent in 2010. It expanded 2.3 percent and 0.32 percent in 2008 and 2009, respectively.

“We believe the BoK’s estimate of the negative output gap is likely to have widened from then (the July meeting) – given the disappointment in July and August data,” Chew said, referring to the difference between actual and potential output.

“Policy support is thus necessary, in our view,” she added.

Over the past month, at least five of the world’s major central banks – European Central Bank, the United States Federal Reserve, Bank of Japan, People’s Bank of China and Reserve Bank of Australia – have implemented various stimulus measures to bolster flagging growth in their respective countries amid a gloomier outlook for the global economy.

This outlook is reinforced on Tuesday by the International Monetary Fund, which cut its 2012 growth forecast for Korea to 2.7 percent, down from an already-lowered estimate of 3 percent. On September 21, the IMF had slashed its estimate from 3.25 percent.

On Monday, the World Bank also cut its growth forecasts for East Asia and the Pacific to 7.2 per cent, down from a projection of 7.6 percent in May.

Like Barclays’ Chew, HSBC’s Man also expects the central bank to revise downwards its estimate for GDP growth this year. The country is “caught by low external demand, economic activity at home is coming to a halt, which will weigh on overall GDP growth,” he said.

HSBC has an estimate of 2.6 percent growth for 2012 and Barclays, 2.7 percent.

By CNCBC's Jean Chua.