Nomura: The cycle of interest rate cuts by the Bank of Korea has come to an end, and the risk of overheating in the economy may force a hike in interest rates.

Nomura Holdings pointed out that the interest rate cut cycle of the Bank of Korea has ended, and it is likely to maintain interest rates in 2026, with the risk of a rate hike now outweighing further easing steps as economic growth strengthens. Nomura economist Jeong Woo Park stated that this shift reflects market expectations that the South Korean economy next year will expand at a pace exceeding potential growth, supported by stronger domestic consumption, a recovery in the construction industry, and the global semiconductor upswing. He added that he expects the South Korean economy to close the gap with potential output around the second quarter of next year, earlier than the Bank of Korea's forecast, reducing the need for further accommodation. Jeong Woo Park said, "Currently, our base forecast is for the policy rate to remain broadly unchanged next year, but from a probability perspective, we believe the risks are tilted towards a rate hike rather than a cut." "If the Bank of Korea does indeed feel pressure to hike rates in the second half of next year, we believe that pressure will ultimately come from inflation." He further added that if inflation remains above the central bank's 2% target for a prolonged period in the second half of next year, policymakers may face increasing pressure to respond. The Bank of Korea has already cut rates by a cumulative 100 basis points since October last year, bringing the policy rate down from 3.5% to 2.5%. Earlier this month, the Bank of Korea kept interest rates unchanged for the fourth consecutive time. Robust economic growth has provided room for South Korean authorities to focus on ensuring that the recovery in the real estate market does not lead to financial instability. Meanwhile, risks such as the depreciation of the South Korean won, trade policy uncertainty, and rising inflation have constrained the Bank of Korea's room for further monetary easing. Data shows that South Korea's consumer price index (CPI) rose by 2.4% year-on-year in November, matching the increase in October and exceeding the surveyed economists' median forecast of 2.3%. In addition, recent signals from the Bank of Korea suggest a more balanced policy debate. At the November meeting, Bank of Korea Governor Lee Choong-ryong stated that there was a divergence among Monetary Policy Committee members on the possibility of a rate cut in the next three months. Subsequently, the market has reduced its expectations of further rate cuts by the Bank of Korea, shifting focus to stable growth CKH HOLDINGS and whether rising inflation risks will eventually prompt a response from the central bank. Jeong Woo Park stated that driven by the expansion of the current account surplus, South Korea is expected to generate over 50 trillion Korean won in additional liquidity by 2026, potentially increasing the pool of funds that could flow into the real estate or asset markets. Despite the expansion of the external surplus, increased overseas investments by households, exporters, and institutional investors like the National Pension Service have eased the pressure of the strengthening of the won and helped offset the impact of the additional liquidity on the currency. Jeong Woo Park added that with the weakening of the US dollar and expectations of rate cuts by the Federal Reserve, the South Korean won is expected to gradually strengthen, reaching around 1,380 won per dollar by the end of next year. However, the South Korean won is currently showing weakness, with the USD/KRW exchange rate at 1,475.5 at the time of writing. Due to ongoing foreign selling of domestic stocks and increased overseas investments by residents, the won has depreciated by over 4% since the fourth quarter, putting pressure on the South Korean authorities to defend the currency. South Korean government officials have expressed concerns about the increasing uncertainty in the foreign exchange market, stating that the persistent imbalance in overseas investments by residents may strengthen expectations of a weakening won and agreeing that it is necessary to actively use all available tools to address this. In response to the rapidly changing foreign exchange market conditions, several departments of the South Korean government convened an emergency meeting on November 24 to discuss specific measures to stabilize the market. The meeting, led by the Ministry of Finance, was attended by the Bank of Korea, the Ministry of Health and Welfare, and the National Pension Service. The focus of the meeting was on how to effectively alleviate the pressure of won depreciation and assess possible intervention measures. As the South Korean authorities attempt to defend the won, the country's state pension fund, the National Pension Fund (NPS), is expected to play a more important role in the financial system in the future to ensure exchange rate stability. With the exchange rate of the won against the dollar nearing a 16-year low and strong expectations in the market for a "structural USD shortage/weak won trend," the South Korean government has transformed the NPS from a "passive large-scale buyer of dollars" to a "quasi-official market regulator for foreign exchange supply and demand," using its massive trading volume to address the imbalance in onshore dollar supply and demand and reinforce the policy signal from the South Korean government aimed at boosting the won. South Korean National Bank economist Minhyeok Lee previously stated that the National Pension Fund (NPS) has resumed selling dollars to support the won, and if the USD/KRW exchange rate falls towards the psychologically significant level of 1 dollar to 1,500 won - the highest level since 2009 - the South Korean authorities may increase efforts to defend the won, with the pension fund potentially taking a more proactive role.