Concerns over exchange rates intensify as the Bank of Korea unexpectedly maintains the interest rate at 3%

According to the Zhitong Finance APP, the Bank of Korea unexpectedly kept the benchmark interest rate unchanged at 3% on Thursday while increasing support for small and medium-sized enterprises to boost the economy. The bank chose to remain calm amid political turmoil and economic slowdown, while also paying attention to the weakness of the currency.

Among the 22 economists surveyed by the media prior to the decision, only 4 predicted that the central bank would maintain the benchmark interest rate. The others expected the central bank to cut rates by 25 basis points to support the South Korean economy, which has been impacted by President Yoon Suk-yeol's shocking martial law order and the Jeju Air crash last month, the worst aviation disaster in South Korea's history.

After deciding to keep the interest rate unchanged, the Bank of Korea stated: "Due to the recent unexpected escalation of political risks, the downside risks to economic growth have increased, and exchange rate volatility has intensified." The central bank indicated that these factors were behind its decision to maintain the interest rate.

The central bank has lowered rates in its last two meetings, with the most recent cut seen as a preemptive measure taken partly out of concern for the impact of the second Trump administration on the economy.

Thursday's decision indicates that most members of the Bank of Korea's board believe they have made sufficient contributions to promote economic growth and are inclined to temporarily focus on the developments in domestic and international situations.

iM Securities Co. analyst Kim Myoung-sil stated: "Three consecutive rate cuts seem to have made it difficult for the Bank of Korea to bear."

After the government announced the rate cut, the Korean won rose slightly, gaining 0.4% against the US dollar on the day. The yield on South Korean government bonds also rose slightly after the announcement, narrowing the day's decline. The South Korean stock market generally accepted the decision, with the KOSPI maintaining an increase of around 1.1%.

On December 3, Yoon Suk-yeol suddenly declared martial law, shocking the nation and the markets, leaving the prospects for the government and the economy uncertain. This failed move ultimately led to the first presidential impeachment since 2016 and the first arrest of a sitting president in South Korea. Yoon was detained on Wednesday and questioned on charges of rebellion.

With Trump returning to the U.S. presidency next week, high tariff threats loom over South Korea's trade-dependent economy, while political turmoil also pressures consumer confidence. The Jeju Air crash at the end of December last year resulted in 179 deaths, further exacerbating the gloom hanging over the South Korean economy. The latest labor market data released on Wednesday showed that the unemployment rate has risen to its highest level in over three years.

However, concerns about the economy were not enough to persuade the Bank of Korea to lower rates for the third consecutive time, especially as the won continues to show signs of weakness.

The won is the worst-performing currency in Asia in 2024, having depreciated more than 12% against the dollar, while Yoon's actions have caused the won to fall to its lowest level in 15 years Given that the Federal Reserve is now expected to lower interest rates at a slower pace, further rate cuts by the Bank of Korea may lead to further depreciation of the Korean won.

Kim from iM Securities stated, "The main reason for the central bank's wait-and-see approach seems to be the exchange rate. The Federal Reserve's intention to slow down its easing measures may also influence the Bank of Korea."

Economist Hyosung Kwon remarked, "This unexpected decision indicates that the central bank wishes to act cautiously due to financial stability risks arising from the depreciation of the won... However, we still believe that further easing policies are imminent."

Keeping interest rates unchanged still leaves the possibility for the Bank of Korea to cut rates in February. A Bloomberg survey shows that economists expect the Bank of Korea to lower its key policy rate to 2.25% by the end of 2025 to boost the economy. The Bank of Korea is expected to further revise its economic growth forecast at its meeting next month.

Kong Dongrak, an economist at Daishin Securities in Seoul, stated, "Although the Bank of Korea acknowledges the need for economic stimulus measures, external factors such as the Federal Reserve and the risks facing the won have prompted the central bank to pause rate cuts. I believe the Bank of Korea's stance on rate cuts has not changed, and today's decision to maintain rates actually implies the next rate cut."

The Bank of Korea indicated that it will closely monitor domestic political conditions, changes in foreign policies, price growth, and exchange rates to determine the timing and pace of any further reductions in the policy rate.

Currently, the Bank of Korea is accumulating ammunition for future needs while seeking government support. Acting President and Finance Minister Choi Sang-mok has promised to increase fiscal spending in advance and announced a holiday at the end of January to stimulate consumption.

The Bank of Korea is also providing more support for small businesses, increasing the aid program amount from 90 trillion won to 140 trillion won (9.6 billion USD).

Maintaining interest rates unchanged also indicates that monetary policy can withstand the pressures of political debate, allowing policymakers to take more time to accurately assess economic conditions while keeping a distance from ongoing turmoil.

Bank of Korea Governor Lee Chang-yong will hold a press conference later on Thursday to answer questions regarding the future direction of interest rate policy. In addition to disclosing how many board members opposed the latest decision, the governor may also outline the board members' expectations for interest rates over the next three months