In a surprising turn of events last Thursday, the Bank of Korea made the unprecedented decision to keep its benchmark interest rate steady at 3%, despite widespread expectations of a reductionThis decision comes at a critical moment when the South Korean economy is grappling with both political tumult and slowing growthThe central bank's action, or lack thereof, has drawn attention as it underscores their commitment to providing support to small and medium-sized enterprises amid a wavering economic landscape.

Prior to the announcement, a survey of 22 economists revealed that only four had anticipated the central bank's decision to hold rates steady, while the rest predicted a 25 basis points cutThe backdrop to these expectations included a state of emergency declared by President Yoon Suk-yeol and a tragic airline disaster involving Jeju Air that marked one of the worst aviation accidents in South Korea's history, claiming 179 lives

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These events have put additional pressure on the economy, prompting calls for decisive action from the central bank.

In its official statement, the Bank of Korea articulated its rationale for maintaining the current rateThey cited an unexpected escalation of political risks that heighten the downward risks to economic growth, as well as increased exchange rate volatilityIn light of these factors, the decision to pause on a rate cut was made to maintain stability in a precarious environment.

The central bank has already implemented rate cuts in its previous two meetings, in part as a preemptive measure to support the economy amidst concerns regarding the new U.Sgovernment’s policiesThis context led many analysts to believe that another rate cut would be an appropriate moveHowever, the determination to maintain rates suggests a collective belief among the central bank's board members that they have already contributed sufficiently to stimulating economic growth, thus preferring to observe the unfolding domestic and international scenarios.

Kim Myoung-sil, an analyst at iM Securities Co., reflected on the board’s sentiment, stating that the central bank is likely feeling the strain of consecutive interest rate cuts

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Following the decision, there was a slight appreciation of the Korean won against the dollar, rising by 0.4%, and government bond yields also experienced a minor uptick, mitigating declines from earlier in the dayMeanwhile, the Korean stock market largely took the news in stride, with the composite index maintaining a gain of about 1.1%.

However, substantial challenges loom over the economy, particularly in light of high tariffs and ongoing political instability, which has dampened consumer confidenceThe devastating Jeju Air crash has added a layer of uncertainty to the economic outlookMoreover, recent labor market data showed unemployment rates rising to their highest level in over three years, further aggravating worries about economic stability.

Yet, these economic fears did not suffice to sway the Bank of Korea into implementing a third consecutive rate cut, particularly given the continuous signs of weakness in the Korean won

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The currency has underperformed significantly, being recognized as the weakest in Asia for 2024, depreciating by over 12% against the dollar, exacerbated by President Yoon’s policies that have contributed to a 15-year low for the won.

As analysts like Kim noted, the primary reason for the central bank's cautious stance appears to be the exchange rate situationAs the U.SFederal Reserve signals a slowing pace for rate cuts, further easing by the Bank of Korea may jeopardize the won, pushing it down even more.

Economist Hyosung Kwon interpreted the central bank's unexpected decision as a reflection of the financial stability risks posed by the depreciating won, prompting a more cautious approachNonetheless, there remains a prevailing sentiment that additional easing measures are imminentIn fact, economists predict that the Bank of Korea may lower its main policy rate to about 2.25% by the end of 2025 to ignite economic growth further.

The decision to maintain the rate also leaves open the possibility for a rate cut in February, as indicated by a Bloomberg survey

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In a climate of uncertainty, it seems the Bank of Korea is biding its time to reassess before committing to further actionAccording to Kong Dongrak, an economist at Daishin Securities, while the central bank acknowledges the need for stimulus measures, external factors such as shifts in U.Smonetary policy and the pronounced risks facing the won led to their decision to pause on rate cutsHe believes the current stance of the Bank of Korea remains unchanged and that holding steady might hint at potential cuts in the near future.

The central bank has pledged to monitor various factors, including domestic political stability, foreign policy changes, inflation rates, and exchange rate movements closely, as these will inform any future rate reductionsMeanwhile, it appears that the Bank of Korea is preparing to stockpile resources for potential future interventions, while actively seeking the government's backing.

In an encouraging move, the acting President and Finance Minister Choi Sang-mok has promised to ramp up fiscal spending as a means of stimulating consumption

This measure comes alongside a commitment to bolster support for smaller businesses, with the allocation for their aid programs being increased from 90 trillion won to 140 trillion won (approximately $9.6 billion).

This decision to maintain interest rates can also be interpreted as demonstrating the central bank’s ability to withstand the pressures of political debates, enabling policymakers to dedicate more time to accurately assess the economic situation while maintaining a protective distance from persistent uncertaintyAs the situation unfolds, Bank of Korea Governor Lee Chang-yong is expected to hold a press conference later in the day to provide insights into the board's future direction regarding interest rate policiesThis gathering will also serve to clarify how many board members opposed the decision to keep rates unchanged and outline their anticipated outlook for rates over the coming three months.