Bank of Korea not following suit?

BOK is not expected to follow the ECB and the PBOC to cut rates this week, says DBS.

DBS Group Research noted:

The Bank of Korea will meet this Thursday to review policy. After the finance ministry revised down the annual growth and inflation forecasts for 2012 to 3.3% (from 3.7%) and 2.8% (from 3.2%) respectively last month, the BOK is widely expected to cut its forecasts too when unveiling the latest economic outlook report this week.

Policymakers will probably raise concerns over the ongoing slowdown in economic growth, led by exports and investment. On the other hand, it is also reasonable for the BOK to tone down the rhetoric on inflation, after seeing headline CPI drop significantly to 2.2% YoY in June on the back of falling oil prices and slowing demand.

The actual inflation rate excluding the impact of the government’s welfare policies is estimated to be in the range of 2.5-3.0%, also tilted towards the lower end of the central bank’s 2-4% target band.

Having said that, we don’t expect the BOK will follow the ECB and the PBOC to cut rates this week. Unlike Europe and China, the slowdown in Korea is externally driven rather than due to home grown factors. The BOK would like to watch the latest development in global economy following the joint efforts of monetary easing from the world’s major central banks last week, before making any key adjustments to domestic monetary policy.

Second, the BOK would want to save options. While the risk of a sharp economic slump resulting from shocks in Europe has subsided, the risk of a renewed deterioration in European debt crisis remains high. The room for the BOK to cut rates to spur domestic growth without creating financial/economic imbalance is actually limited, given the benchmark interest rate at 3.25%, actual inflation at 2.5-3.0% and real rate of about only 0.5%.

Thirdly, the BOK should remain mindful about the side effects of premature monetary loosening and liquidity excessiveness. Broad money supply growth is currently running at 8.6% YoY, still outpacing the trend growth in nominal GDP of 7-7.5%. Inflation could rebound strongly once growth momentum returns, especially because consumers’ inflation expectations for the next one year remain high at 3.7%.

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