S.Korea cuts interest rate to all-time low of 1.5 pct on MERS woes

Bank of Korea (BOK), South Korea's central bank, cut its policy rate Thursday to an all-time low of 1. 5 percent on concerns that the unabated spread of the Middle East Respiratory Syndrome (MERS) may erode the already lackluster economy.

BOK Governor Lee Ju-yeol and six other members of the monetary policy board decided to lower the benchmark seven-day repurchase rate by a quarter percentage point to 1.5 percent. The bank cut it below 2 percent in March for the first time in history after lowering it by 25 basis points in August and October last year each.

The rate cut was roughly unexpected as many experts predicted the rate freeze on surging household debts that will be boosted further by lower lending rates. According to a Korea Financial Investment Association (KFIA) poll of 117 fixed-income experts, 70 percent of respondents expected the rate on hold.

The unexpected decision came as MERS infections increased to 122 on Thursday after 14 more cases were added. Consumers refrained from going outside for shopping, and many of social and political gatherings were cancelled.

The BOK said in a statement that downward risks got stronger to a growth path forecast in April, citing the faster pace of export reduction and the MERS outbreak. The bank revised down its 2015 growth outlook in April by 0.3 percentage points to 3.1 percent.

President Park Geun-hye ordered economy-related ministries Tuesday to take all available measures to proactively minimize the MERS effect on the economy. Park decided Wednesday to postpone her planned visit to the United States next week to focus on containing the MERS spread.

The state-run Korea Development Institute (KDI) recently revised down its 2015 growth outlook for the economy by 0.5 percentage points to 3.0 percent, warning that this year's growth rate may fall below the level if the central bank fails to cut rates further. Finance Minister Choi Kyung-hwan shared the view, saying he had a similar thinking with the KDI.

MERS OUTBREAK, SLOW EXPORTS

Retail sales showed slight signs of recovery, but consumer confidence hit a snag as the first MERS case was found on May 20. Sales in department stores and discount chains grew 3.6 percent and 0.3 percent each in May from a year earlier, but credit card usage, which gauges private consumption, rose 7.1 percent in May, less than half of a 15.4 percent increase in April.

Sales in gasoline and diesel, another measurement of consumption, dipped 2.2 percent in May, down from an 8.7 percent growth in April. Local car sales slid 0.2 percent in May after gaining 5.5 percent in March and 2.8 percent in April each.

Exports, which account for about half of the economy, declined at a faster pace this year from a 0.9 percent fall in January to slides of 3.3 percent in February, 4.3 percent in March, 8.1 percent in April and 10.9 percent in May.

Production in all industries reduced 0.5 percent in March and 0. 3 percent in April each, and the headline inflation stayed at a zero-percent level for six straight months. The youth jobless rate fluctuated around 10 percent.

SURGING HOUSEHOLD DEBTS

The rate cut was expected to deepen worries about surging household debts amid the lowest interest rates. Debts owed by households to banks and non-bank deposit takers, including savings banks and credit unions, rose 10.1 trillion won (9 billion U.S. dollars) in April alone, marking the largest monthly increase in history.

The record expansion came a month after the BOK's rate cut in March. The previous record was tallied in October 2014 when the household debts grew 7.8 trillion won after easing regulations on mortgage financing.

Among the May increase was 8 trillion won of home-backed loans, indicating a fast growth in home purchases by borrowing money from financial institutions. Nationwide housing transactions surged 40. 5 percent in May from a year ago. For the first five months of this year, the transactions soared 25.2 percent from the same period of last year.

The record-low interest rates could trigger a foreign fund exodus from the South Korean financial market as U.S. Federal Reserve Chair Janet Yellen indicated the first rate hike, since the 2008 financial crisis, by the end of 2015.

If the Fed begins to normalize its federal fund rate, the BOK would follow suits belatedly, but the BOK's rate hike could face a bigger setback as the rate hike would increase debt-servicing burden for households, the majority of them incapable of paying back principal. Enditem