Korea's inflation pegged at 2%

Will the government cut rates?

According to DBS, the Bank of Korea meets this Thursday and it expects no policy change. DBS noted that the actual inflation excluding government subsidies is estimated to be about 2.0%, providing flexibility for the central bank to reduce rates from the current 2.75%.

Here's more:

Market talk about a rate cut has not fully subsided. Although the BOK decided to hold rates steady at the last meeting in April, the vote was fairly close (4 against 3) and opinions were highly divided amongst the committee members.

GDP growth remained subpar in 1Q and recent trade data suggested that the economy continues to stay on a soft patch in 2Q. Inflation is low at 1.2%.

The actual inflation excluding government subsidies is estimated to be about 2.0%, providing flexibility for the central bank to reduce rates from the current 2.75%.

Nonetheless,the flexibility of cutting rates doesn’t mean the central bank will actually do so. There is normally a six month time lag for monetary policy to work through the economy.

On expectations of below-trend growth in 1H13, the BOK already pre-emptively lowered rates by 50bpsin 2H12. The current policy direction largely hinges on the economic outlook in the next two quarters, rather than the conditions at present.

The BOK holds the view that the economy will return to the 4% trend growth rate in 2H, it implies that the output gap will be closed subsequently and inflation pressures will emerge in 2014.

A rate reduction should be based on a downward revision to the 2H outlook. For now, there are still no signsshowing that the economy will deviate from the central bank’s projection of a recovery trend in 2H.