Political turmoil and plane crashes threaten the South Korean economy. Is the South Korean central bank ready to make three consecutive interest rate cuts?

The financial markets widely expect the Bank of Korea to cut its benchmark interest rate this week, temporarily setting aside concerns about financial stability and instead focusing on boosting the series of political turmoil caused by the unexpected martial law by President Yoon Seok-yul, as well as the severe damage suffered by the South Korean economy due to the recent deadly airline crash. After experiencing two consecutive interest rate cuts, the Bank of Korea's monetary committee faces a difficult decision, but with South Korea's economy heavily reliant on export trade, the prospect of political turmoil weakening South Korean business confidence and the shadow cast by Donald Trump's tariff plans, they may ultimately shift their focus to supporting the already weak South Korean economy. Of the 22 economists surveyed by Bloomberg, 18 believe that the Bank of Korea will choose to cut interest rates by 25 basis points to 2.75% during the rate meeting on Thursday. If reality matches their expectations, this will be the third consecutive interest rate cut since the Bank of Korea shifted its policy towards a more accommodative stance in October of last year, and the longest period of continuous accommodative policy since the global financial crisis. The other four economists predict that the South Korean benchmark interest rate will remain unchanged. President Yoon Seok-yul unexpectedly declared a state of emergency on December 3, shocking the nation and eventually leading to Yoon's impeachment by the National Assembly, which has exacerbated pessimism in the South Korean economy. The acting president of South Korea, Prime Minister Han Deok-soo, was also impeached, and Finance Minister Choi Sang-mook currently serves as the acting president. The series of turmoil in the South Korean political arena since December has caused a significant decline in overall business confidence in South Korean companies, and some small and medium-sized South Korean enterprises have begun to worry about delays or cancellations of some potential subsidy policies at the policy level due to the continued instability at the highest levels of South Korea's leadership. This series of government crises has also led to the largest decline in South Korean consumer confidence since the outbreak of the global COVID-19 pandemic in 2020. Furthermore, at the end of December last year, South Korea experienced its most serious civil aviation disaster when a Jeju Air aircraft crashed at a southwest airport, resulting in the deaths of all 179 people on board. This action has sparked a wave of resistance against civil aviation in South Korea, with some citizens canceling flights and switching to land transportation systems. The political turmoil caused by the state of emergency has severely damaged consumer confidence in South Korea - the December consumer confidence index fell by 12.3 points compared to the previous month. "Indeed, there have been many events in the past month that could determine the direction of policy in the near future," a report by the Bank of America economists led by Jung Hyun-ho states. "Some may think that given the increasing hawkishness of the Federal Reserve, South Korea is unlikely to announce another consecutive rate cut, but we believe that persistent internal economic uncertainty could have a greater impact." Federal Reserve officials have shifted their focus to the risk of inflation resurging under President Trump's leadership, which has limited the prospects for significantly easing policies. The Bank of Korea has long been closely monitoring the policy impact of the Fed, but its concerns about consumer price growth have eased, with inflation in South Korea expected to be slightly below its 2% target by 2025. Meanwhile, the policy focus of the Bank of Korea has shifted towards promoting economic growth, as members of the Bank of Korea's Monetary Policy Committee remain concerned about Donald Trump returning to power and his promise to impose tariffs, which could put significant pressure on economies like South Korea that rely on exports. Donald Trump, who is set to return to the White House in January, has previously promised to impose high tariffs on imported goods from major trading partners, including China (South Korea's largest trading partner). Economists generally believe that with increasing concerns about the Trump administration imposing tariffs on more countries globally, South Korea's export growth momentum may significantly slow down over the next year. Economists widely believe that South Korea's private spending is increasingly weak, the rebound in South Korean exports under pressure from Trump's tariffs may significantly cool down, and deteriorating consumer confidence are all core factors prompting the Bank of Korea to accelerate its loosening steps. The Bank of Korea unexpectedly lowered the South Korean benchmark borrowing cost by 0.25 percentage points in November for fear of tariffs that Trump might impose after taking office in January. Bank of Korea Governor Lee Chan-ryeong has previously stated that economic growth may be lower than the previously forecasted 1.9%. Some of the pessimism stems from a slowdown in chip export growth, which is the largest driving force behind South Korea's economic growth. The United States is increasingly tightening restrictions on the export of high-performance chip-related products to China, which also increases the risks faced by South Korea in its exports focused on memory chips such as HBM and data center NAND. The analysis team from iM Securities stated in a report, "If exports slow significantly, especially semiconductor exports, and economic conditions continue to deteriorate with no expected improvement in the short term, the downward risk to domestic GDP growth in the first quarter of 2025 may increase significantly." "While South Korea's exports to the United States remain relatively strong, especially in technology product exports, overall exports began to soften at the end of 2024," Goldman Sachs economists Hong Gu-xun and Andrew Tilton said in a report. "Amid various factors, South Korea's exports to other destinations remain weak, particularly to China, undermining overall export performance." The monetary policy decision on Thursday may still be a close contest within the Bank of Korea, as many economists expected a rate cut this month are avoiding displaying overly confident tones. The won is still struggling to regain strength, export growth has not turned negative, market concerns about household debt persist, all adding to the reasons for the Bank of Korea to keep rates unchanged after two consecutive rate cuts. Trump will not officially take office until January 20, and policymakers may hold off on taking action until he announces enough tariff details to more accurately calculate their impact and adjust policies accordingly. The government has also front-loaded fiscal spending to prevent further deterioration in consumer confidence, and even designated a one-time holiday at the end of January. "With the government front-loading fiscal spending and preparing to increase the budget, if economic growth collapses, we expect the Bank of Korea will not cut rates to boost short-term market sentiment and economic growth," said Nomura Holdings economist Park Jeong-yu.Display.South Korean Business Confidence Index Deteriorates Political Turmoil, Trump's Return Impact Business Confidence A survey conducted by Bloomberg after the brief lifting of martial law shows that economists maintain their forecasts for South Korean economic growth in 2024 and 2025 at 2.2% and 1.8% respectively. They also predict that the Bank of Korea will cut interest rates to 2.25% by the end of 2025, which is consistent with previous forecasts. However, they have brought forward their prediction for the last rate cut of the year to the third quarter, between July and September. With South Korea still focused on the Constitutional Court's impeachment trial of President Yoon Seok-yul, these views may change. Yoon is resisting police attempts to detain him for questioning about alleged rebellion charges related to the imposition of martial law, which involved sending troops to the National Assembly. Economist Tan Junyu from Coface said, "Political turmoil is occurring at a time when the South Korean economy is in a weak period. Various voices surrounding the decision-making process may persist until a final judgment is made." Currently, the Bank of Korea seems to be in a dilemma. If the bank chooses to cut rates on Thursday, the South Korean won may further weaken, private debt levels may rise again, and the real estate market may reignite. If rates are kept unchanged, criticism may continue as some economists fear that South Korea might be missing the right timing to support the economy, as policy decisions often take months to be transmitted. "We do not rule out the possibility of a tie vote of 3-3 among the Bank of Korea's committee members, making the vote of the bank's governor decisive," said Jeeho Yoon, economist at BNP Paribas in France. "We believe there are valid reasons both for cutting rates and keeping them unchanged."