Bank of Korea pressured to cut policy rate

But analyst predicts rate to stay at 2.75%.

According to Nomura, it now sees a risk that the BOK is forced to cut rates in the name of “policy coordination with the government”. 

It adds that if the new Finance Minister overestimates the downside risks to growth or focuses too much on a part of the economy (instead of overall GDP), the government would implicitly press the BOK to deliver further monetary easing. Markets have already priced in this risk.

Here's more:

Korea‟s debt-to-GDP ratio rose to 260% in 2012, but its five-year rolling rate of change fell from 61 percentage points (pp) in 2009 to 41 pp in 2012. The Asian currency crisis and the Lehman crisis both occurred after the five-year rate of change in Korea‟s leverage surged to 50pp.

Korean policymakers have succeeded in slowing the increase of leverage, at least for now, but the stillhigh figure (both in the level and rate of change of leverage) suggests that Korean policymakers should be cautious in implementing macro policies that could further raise the economy‟s leverage ratio. 

In this regard, the BOK‟s decision on monetary policy now will determine whether Korea falls into debt-overhang economy or overcomes the temptation of debt-driven growth. We believe lower interest rates would encourage excessive financial leverage if the government‟s stimulus package included a supplementary budget and property market deregulation.

Protracted low rates could lead to even higher financial leverage, making the economy vulnerable to a potential inflation shock, given that the debt overhang will not likely shrink quickly enough to absorb higher global interest rates in the future.

The creation of market  expectations of a low interest rate regime that continues despite an economic recovery risks creating new types of bubbles.

Our concern is that a debt overhang could limit the effectiveness of monetary policy and the Korean economy could fall into a vicious cycle: lower interest rates result in higher debt; domestic demand weakens as unproductive or inefficient public sectors, corporates and households take most of the newly available loans; the BOK can do nothing except maintain the low interest rates to support the highly leveraged economy. 

It is a very close call, but we expect the BOK to keep rates unchanged at 2.75% in April and for the rest of this year. Because of increasing political risks, however, we now assign a 40% likelihood to a 25bp rate cut in April and a 60% likelihood to the BOK leaving rates unchanged.

If the BOK is forced to cut rates, we would consider it a policy mistake.