🚨 Analysis of Bank of Korea Interest Rate Cut and Economic Growth Rate Decline
Today Korean Economic News | 2025.02.26
📌 Growth Outlook Plummets to 5%... Bank of Korea Lowers Interest Rate for 'Domestic Demand Recovery'
💬 The Bank of Korea has cut the base rate by 0.25 percentage points from 3.00% to 2.75%. The rate cut appears to be aimed at stimulating domestic demand as the growth rate forecast was significantly lowered from 1.9% to 1.5%. However, concerns about exchange rate and inflation also exist as the United States is slowing down its interest rate cuts.
1️⃣ Easy Understanding
The Bank of Korea has decided to lower the base rate. This is a measure to stimulate our economy, which is progressing much slower than expected. I'll explain in simple terms what this decision means and how it will affect our economy and daily lives.
The base rate is the interest rate that the central bank, the Bank of Korea, applies when lending money to other banks. When this rate decreases, it affects all rates in the market (deposits, loans, etc.). This time, the Bank of Korea lowered the base rate from 3.00% to 2.75%, a decrease of 0.25 percentage points. This is the first rate cut decision that breaks away from the high interest rate stance maintained since early 2023.
Why was this decision made? The biggest reason is that our economic growth rate is significantly slowing down. The Bank of Korea has drastically revised down its economic growth forecast for this year from 1.9% to 1.5%. The fourth quarter growth rate was lower than expected at 0.6%, and the first quarter growth rate for this year is also predicted to be very poor at around 0.1%.
How will this be felt in daily life? First, various loan rates such as mortgage loans and credit loans will decrease slightly. For example, a household with a 300 million won mortgage loan could see their monthly interest burden reduced by about 75,000 won. Companies may also have more capacity to increase investment and employment as loan costs decrease.
On the other hand, deposit interest rates will also decrease, reducing interest income from savings. If you put 100 million won in a one-year fixed deposit, your interest income could decrease by about 250,000 won annually.
Additionally, the interest rate cut may lead to a decrease in the value of the Korean won (rise in exchange rate). In fact, the won/dollar exchange rate rose immediately after the rate cut announcement. This could drive up import prices, creating inflationary pressure.
The Bank of Korea's decision can be seen as an inevitable choice to prevent economic recession, but it also brings new challenges. Particularly in a situation where the United States is taking a cautious attitude toward interest rate cuts, if Korea alone hastily lowers rates, there are concerns that exchange rate instability could worsen. Therefore, future additional rate cuts are expected to be decided carefully, comprehensively considering not only domestic economic conditions but also U.S. interest rate policy and the global economic environment.
2️⃣ Economic Terms
📕 Base Rate
The base rate is the interest rate applied by the central bank when lending funds to commercial banks, affecting the overall market interest rate level.
- As a central bank's monetary policy tool, it has tightening effects when raised and stimulating effects when lowered.
- It directly affects market rates such as loan and deposit rates and corporate bond rates, influencing consumption and investment.
📕 Economic Growth Rate
Economic growth rate is an indicator showing how much a country's production has increased over a certain period.
- It is usually measured as the increase rate of Gross Domestic Product (GDP) compared to the previous year or previous quarter.
- It is an important indicator for evaluating the health of the economy and is directly linked to job creation and improvement in living standards.
📕 Domestic Demand
Domestic demand refers to domestic economic activities including domestic consumption and investment.
- It consists of private consumption, government spending, and corporate investment, representing domestic economic vitality excluding exports and imports.
- Stimulating domestic demand is an important factor in increasing the resilience of the domestic economy against external economic shocks.
📕 Exchange Rate
Exchange rate is the ratio of exchange between one country's currency and another country's currency, affecting imports, exports, and prices.
- It is influenced by various factors such as interest rates, current account balance, foreign investor fund flows, and international situation.
- Korean won depreciation (exchange rate increase) simultaneously brings effects of strengthening export competitiveness and increasing import prices.
3️⃣ Principles and Economic Outlook
💡 Background and Significance of Bank of Korea's Interest Rate Cut
Behind the Bank of Korea's decision to cut the base rate lies serious concern about economic growth slowdown.
First, the drastic downward revision of economic growth forecast is the main reason. The Bank of Korea has revised down its economic growth forecast for this year from 1.9% to 1.5%, a decrease of 0.4 percentage points. This is the result of a complex interplay of global economic slowdown, delayed recovery in major export sectors such as semiconductors, and weak domestic demand. In particular, the fourth quarter growth rate of 2024 was lower than expected at 0.6%, and the first quarter growth rate of 2025 is also expected to remain at a very poor level of 0.1%, significantly increasing the downside risk to the economy.
Second, domestic demand stagnation is becoming prolonged. Private consumption has significantly contracted due to increased household debt burden from high interest rates, real estate market downturn, and employment market instability. Companies have also reduced investments, lowering the overall vitality of domestic demand. Recent retail sales index has been continuously decreasing, and facility investment and construction investment also show weak trends, making policy response to recover domestic demand an urgent situation.
Third, inflationary pressure has eased. The main reason the Bank of Korea has maintained a high interest rate stance so far was to curb inflation. However, as the consumer price inflation rate has stabilized to the target level of 2%, a policy shift focusing on growth rather than prices has become possible. The consumer price inflation rate for January 2025 was 2.1%, showing a gradual stabilization trend in prices.
Fourth, changes in global monetary policy stance were also considered. As major countries' central banks signal the possibility of interest rate cuts, global monetary policy is showing signs of transitioning from tightening to easing. Particularly as the U.S. Federal Reserve System (Fed) has signaled interest rate cuts in the latter half of this year, conditions for the Bank of Korea to cut rates have also been created.
The base rate cut implemented against this background carries meaning beyond a simple numerical change. It signifies a policy paradigm shift from 'price stability-centered' monetary policy to 'economic stimulus-centered'. It is also a signal flare announcing the beginning of a new monetary policy cycle, breaking away from the high interest rate stance that has continued for the past two years.
💡 Impact of Interest Rate Cut on Economic Agents
The Bank of Korea's base rate cut has different impacts on economic agents such as households, businesses, and the government.
First, the impact on households. The most immediate effect of a base rate cut is the reduction in loan interest burden. As rates for variable-rate mortgage loans, credit loans, etc. decrease, households' principal and interest repayment burden reduces. In the current situation where household debt amounts to about 1,900 trillion won, a 0.25 percentage point rate cut is estimated to bring an annual interest burden relief effect of about 4.8 trillion won. This can lead to increased disposable income, raising consumption capacity. On the other hand, deposit rates will also decrease, potentially reducing the income of the elderly and retirees who depend on interest income. There is also a possibility of household asset portfolio adjustment due to expectations of asset price (especially real estate) increases.
Second, the impact on businesses. Businesses gain capacity to expand investment and employment as funding costs decrease. Particularly for small businesses and self-employed individuals with high loan dependence, the positive effects of the rate cut may be more significant. A base rate cut leads to decreased corporate bond rates and business loan rates, improving companies' financial conditions and increasing liquidity. However, increased import raw material prices due to won weakness may act as a burden for some companies.
Third, the impact on the government and financial markets. From the government's perspective, the burden of fiscal operation decreases as the cost of issuing government bonds decreases. In the current situation where national debt is rapidly increasing, the rate cut brings interest cost saving effects. In financial markets, bond price increases and stock market activation are expected. Interest rate cuts generally have a positive impact on the stock market, particularly increasing the investment attractiveness of high dividend stocks and growth stocks. The real estate market may also see activated transactions and stabilized prices due to the rate cut.
Fourth, the medium to long-term impact on the overall economy. The rate cut leads to expanded money supply and increased liquidity, contributing to domestic demand activation. As consumer and business sentiment improves, consumption and investment increase, which can lead to economic growth rate recovery. However, there is also the possibility that import price increases due to won depreciation may act as inflationary pressure. Additionally, the risk of deepening financial imbalances as household debt increases again should also be considered.
As such, interest rate cuts have a wide-ranging impact on the overall economy, with positive effects and side effects coexisting. Since there is a certain time lag for the effects of interest rate cuts to spread to the real economy, careful monitoring of the time lag and magnitude of policy effects is necessary.
💡 Future Monetary Policy Outlook and Economic Recovery Scenarios
After the Bank of Korea's first interest rate cut, various outlooks are being presented regarding future monetary policy and economic recovery paths.
First, the outlook on the possibility and speed of future additional rate cuts. The market expects one to two additional rate cuts within this year. However, the speed of additional cuts will be determined by domestic economic conditions, price trends, U.S. interest rate policy, and global financial market conditions. If the U.S. Federal Reserve delays the timing of interest rate cuts or reduces the size of cuts compared to initial expectations, the Bank of Korea is also likely to be cautious about additional cuts. Particularly if the interest rate gap between Korea and the U.S. widens, won weakness pressure may increase, making exchange rate impact an important consideration in interest rate policy decisions.
Second, the economic recovery path and domestic demand activation outlook. While interest rate cuts immediately reduce households' interest burden and improve businesses' investment conditions, time is needed for this to lead to actual economic recovery. Generally, it takes 6-12 months for the effects of interest rate cuts to fully manifest in the real economy. Therefore, economic recovery is expected to become visible from the second half of 2025. However, sustainable economic recovery is possible only when the interest rate cut is accompanied by government fiscal policy, regulatory reform, and securing structural growth engines.
Third, potential risk factors following the interest rate cut. Along with economic stimulus effects, the interest rate cut also entails several potential risks. First, there is the possibility of excessive household debt increase and asset price bubble formation. Financial imbalances may deepen as funds flow into asset markets such as real estate in a low interest rate environment. Additionally, exchange rate volatility expansion and inflationary pressure due to won weakness are elements that need to be carefully monitored. Particularly if foreign investor funds outflow due to the widened interest rate gap between Korea and the U.S., this could lead to financial market instability.
Fourth, the need for long-term economic structural improvement. The interest rate cut is merely a short-term prescription for economic stimulus; more fundamental reforms are needed to solve the structural problems of the Korean economy. Structural challenge factors such as low birthrate and aging population, productivity stagnation, and industrial structure dualization are difficult to solve with monetary policy alone. Therefore, a comprehensive policy package including labor market reform, industrial competitiveness enhancement, and social safety net expansion should be implemented along with monetary policy.
Overall, the Bank of Korea's interest rate cut is an important first step to breathe life into the stagnant economy, but various policy efforts must be pursued in parallel for sustainable economic recovery and growth. It is a time requiring careful policy combinations and market monitoring to maximize the effects of the interest rate cut and minimize side effects.
4️⃣ In Conclusion
The Bank of Korea's base rate cut can be seen as an inevitable choice to respond to economic growth slowdown. In a situation where the growth rate forecast has fallen to 1.5%, it is a policy decision aimed at promoting economic recovery through domestic demand activation. This signifies the beginning of a new monetary policy cycle, breaking away from the high interest rate stance that has continued for more than two years.
The interest rate cut is expected to bring various positive effects such as reducing households' interest burden, improving businesses' investment conditions, and easing the government's fiscal operation burden. In particular, as the interest burden on household debt, which amounts to 1,900 trillion won, decreases by about 4.8 trillion won annually, this may lead to increased disposable income and activated consumption. Also, as businesses' funding costs decrease, conditions for expanded investment and employment are created.
However, there are also potential risks to the interest rate cut. It is necessary to carefully monitor import price increases due to won depreciation, excessive household debt increases, and the possibility of asset price bubble formation. Particularly in a situation where the U.S. is slowing down the pace of interest rate cuts, if the interest rate gap between Korea and the U.S. widens, exchange rate volatility may increase, making additional rate cuts likely to be carried out cautiously.
Future monetary policy will be determined by comprehensively considering domestic economic conditions, price trends, U.S. interest rate policy, and the global economic environment. The market expects one to two additional rate cuts within this year, but the speed and magnitude may be adjusted according to changing situations.
The important point is that the structural problems of the Korean economy cannot be solved by interest rate cuts alone. To respond to fundamental challenge factors such as low birthrate and aging population, productivity stagnation, and industrial structure dualization, a comprehensive policy package including fiscal policy, regulatory reform, labor market improvement, and industrial competitiveness enhancement is needed along with monetary policy.
Ultimately, the Bank of Korea's interest rate cut is an important policy signal to breathe life into the stagnant economy, but for sustainable economic recovery and growth, active cooperation between the government and private sectors and structural reform efforts must be pursued in parallel. As it takes time for the effects of interest rate cuts to spread to the real economy, various economic indicators should be monitored with patience, and the effects and side effects of the policy should be carefully managed.