Bank of Korea Cuts Rate to 2% and Sees Room for More

By William Sim

Feb. 12 (Bloomberg) -- The Bank of Korea cut its interest rate to a record-low 2 percent and Governor Lee Seong Tae said there’s scope for another reduction to revive an economy that last quarter shrank the most in 10 years. The local currency fell.

The bank pared the seven-day repurchase rate by a half point today, the sixth reduction since early October. “The possibility of a further rate cut is still open,” Lee said in Seoul. “We can also take various other steps to provide liquidity. It’s very likely the economy will contract a lot this year.”

Recession is looming for the first time since Asia’s 1997- 1998 financial crisis on declining demand from China, Europe and the U.S. for South Korea’s exports. Woori Finance Holdings Co., owner of the nation’s second-biggest bank, today posted its first quarterly loss in almost five years, and LG Electronics Inc., the world’s third-largest maker of mobile phones, said this week it plans to reduce costs and may cut workers as sales drop.

“The Bank of Korea has more room to cut interest rates because the economy is cooling and the credit crunch hasn’t been fully resolved,” said Lim Jiwon, a senior economist at JPMorgan Chase & Co. in Seoul, who forecasts a quarter-point cut in March. “Companies and households are still having difficulties.”

Finance Minister Yoon Jeung Hyun pledged this week to step up stimulus spending after forecasting the economy will shrink 2 percent this year and lose about 200,000 jobs, which would be the biggest employment decline since 1998.

Stocks Decline

The Kospi stock index fell 0.9 percent to 1,179.84 at the close in Seoul, the fourth straight drop. The won, Asia’s worst- performing currency last year, shed 0.8 percent to 1,404.50 per dollar close to its lowest level in two months. The yield on the five-year government bond slipped 1 basis point to 4.52 percent.

Governor Lee has cut rates by 3.25 percentage points since Oct. 9, the most aggressive easing undertaken since the central bank began setting a policy rate a decade ago. Today’s move was expected by six of nine economists surveyed by Bloomberg News.

Central bankers around the world have slashed borrowing costs as economies including the U.S., Europe and Japan sink into recessions because of fallout from the global credit freeze.

As conventional monetary policy tools lose their potency, policy makers are seeking new ways to prop up flagging economies and revive their financial systems.

“The board will do what is needed to improve liquidity conditions and to ward off the risk of a severe slowdown,” the Bank of Korea said today. “The economy is shrinking fast across the board, including demand, production and employment.”

New Moves

Governor Lee didn’t specify what further measures the Bank of Korea may undertake to bolster liquidity in the economy.

Bank of England Governor Mervyn King said yesterday the U.K. is in a “deep recession” that may force policy makers to create money and pump it into the economy after cutting interest rates to a record low of 1 percent. The Federal Reserve is considering buying long-term Treasuries after reducing the U.S. benchmark interest rate to almost zero.

“The question now is what’s to come next after the Bank of Korea is done with rate cuts,” said Seo Chul Soo, a fixed-income analyst at Daewoo Securities Co. in Seoul, adding the central bank could consider buying government bonds directly to help stabilize the long-term debt market.

Yoon, who took office this week and was the first government minister to predict a recession in 2009, said he’ll increase spending “as soon as possible” in addition to the 51 trillion won ($36 billion) in stimulus already allocated. The government will propose an extra budget to parliament by the end of March, he said on Feb. 10.

Bank Aid

The government is setting up a 20 trillion won fund to buy banks’ preferred stock and subordinated debt as the weakening economy increases bad loans and erodes lenders’ capital.

Overseas shipments, which make up about 60 percent of gross domestic product, tumbled by a record 32.8 percent in January.

Factory output plunged an unprecedented 18.6 percent in December, as exporters Hyundai Motor Co. and Hynix Semiconductor Inc. cut output to cope with sagging demand. Borrowing by households decreased for the first time in a year last month.

LG Electronics plans to cut costs by 3 trillion won in 2009.

“Inevitably, there may be layoffs as we try to optimize the overseas manufacturing plants, but there won’t be any job cuts for the time being,” Chief Executive Officer Nam Yong said on Feb. 9. The current economic environment is “difficult for all global players,” Nam said.

Woori Finance reported a 664.8 billion won loss in the three months ended Dec. 31 as it increased provisions for bad loans. Kookmin Bank, South Korea’s biggest lender, posted a quarterly loss yesterday.

To contact the reporter on this story: William Sim in Seoul at wsim2@bloomberg.net