25bps rate cut looms in Korea

Blame it on the pressure from depressing economic growth.

According to DBS, the Bank of Korea (BOK) is widely expected to cut rates by 25bps from 3.00% to 2.75% when they meet tomorrow morning. The persistence of sluggish economic growth kept the BOK under pressure to continue to ease monetary policy.

Here's more from DBS:

Real GDP growth has slowed to a poor 1.1% QoQ saar in 2Q. Exports and manufacturing PMI deteriorated further in July before stabilizing at low levels in August, which points to the risks of a further GDP growth slowdown in 3Q.

The call is growing for policymakers to consider additional stimulus measures. The finance ministry this week announced a stimulus package including both spending (mainly on social safety nets, local government budget) and temporary tax cuts (property transaction tax, consumption tax on automobiles and electronics).

The overall size of the stimulus package is not large, which amounts to KRW 5.9trn and is equivalent to only 0.4% of GDP. The government remains reluctant to expand fiscal policy substantially through an extra budget. Prudent fiscal management has been a consistent principle in Korea.

Moreover, a supplementary budget is only allowed to be used in the event of wars, disasters or economic recessions. The current economic situation doesn’t meet the prerequisite for drawing up a supplementary budget.

As the scale of fiscal stimulus is limited, we believe the central bank will be under greater pressure to add monetary stimulus in the economy. One rate cut of 25bps can reduce the interest costs for corporate and household borrowers by 0.2% of GDP.

Importantly, inflation has eased significantly, providing sufficient room for the BOK to deliver the needed monetary stimulus. Headline CPI stood at 1.2% YoY in August. Excluding the distortion impact of government subsidies, the actual inflation rate should be running at 2.0% currently.

We expect inflation average of 2.1% in 2012 and 2.5% in 2013. The inflation adjusted short-term real rates will be kept in the positive territory even if the BOK cuts the benchmark rate to the mid-2% level from the present 3.00%.