Bank of Korea cuts growth, inflation forecasts on market turmoil

Governor of the Bank of Korea Lee Ju Yeol attends a monetary policy meeting in Seoul, South Korea, on Jan 14, 2016.
Governor of the Bank of Korea Lee Ju Yeol attends a monetary policy meeting in Seoul, South Korea, on Jan 14, 2016. PHOTO: BLOOMBERG

SEOUL (BLOOMBERG) - The Bank of Korea cut its forecasts for economic growth and inflation while holding its key interest rate at a record low as instability from China reverberates in global financial markets.

Governor Lee Ju Yeol said gross domestic product will expand 3 per cent in 2016, down from a forecast of 3.2 per cent while consumer prices will rise 1.4 per cent, versus a previous estimate of 1.7 per cent. The seven-day repurchase rate was left at 1.5 per cent for a seventh month, as projected by 15 of 16 economists in a Bloomberg survey.

Governor Lee faces the task of spurring inflation to a new 2 per cent target and shoring up the South Korean economy as exports decline. Adding to the challenges, the BOK now has less room for further monetary easing, with household debt at record levels and greater risk of capital outflows as the US raises interest rates and instability increases in China.

"The BOK will probably lower growth and inflation forecasts, but will hold the view that the recovery trend is valid on domestic demand," Stephen Lee, a Seoul-based economist for Samsung Securities Co, said before the decision. "The BOK wouldn't want to go in the opposite direction of the Fed and would prefer to stand pat amid current global market uncertainties."

Several BOK board members said at the Dec 10 policy meeting that downside risks to Korea's economic growth are rising as a result of a yearlong exports slump and external uncertainties including the drop in oil prices, according to the meeting's minutes.

A sell-off in Korean equities triggered by China's slower growth weakened the won to a more than five-year low this week. While that may have some benefits, a disorderly move in the financial market hurts investor sentiment and can disrupt corporate business plans.  There is also concern that foreigners may reduce their holdings of Korean bonds as longer-term sovereign debt is yielding less than similar maturity notes in the US.

Korea's 10-year government bond yield was 2.03 per cent when the local market closed ON Wednesday, compared with 2.13 per cent for Treasuries of similar maturities around the same time.