BOK cut coming; Fed cannot weaken USD

The Bank of Korea will pave the ground for a rate cut in August. Fed cut expectations have not offset the weaknesses in its largest components, the euro and the British pound.
Ma Tieying, Philip Wee17 Jul 2019
    Photo credit: AFP Photo

    BOK rate cut on the way

    The Bank of Korea is likely to downgrade growth and inflation forecasts when releasing the quarterly economic outlook report tomorrow. This will pave the way for the BOK to lower the benchmark repo rate by 25bps to 1.50% at the meeting in August.

    The BOK is facing the pressure to provide monetary stimulus to bolster the economy. Exports, PMI, industrial production and consumer confidence have weakened on a broad basis since May/June. Despite the US-China trade truce, new headwinds come from Japan’s curb of high-tech exports to South Korea. The BOK’s 2019 GDP growth forecast, which stands at 2.5% currently, is too optimistic, in our view (DBSf: 2.1%).

    CPI inflation averaged 0.6% YoY in 1H, well below the official target of 2% and full-year forecast of 1.1%. Housing prices have continued to moderate through 1H, thanks to general economic slowdown and the government’s cooling measures. The KRW’s volatility has also eased somewhat since late-May, alongside the recovery in current account balance.

    Rate cut expectations have pushed down KTB yields by about 40bps YTD across the 2-10Y tenor. Foreign bond inflows surged for two consecutive months in May (USD7.1bn) and June (USD5.8bn). But lower yields and easier financial conditions have not helped much in lifting growth expectations. The KOSPI has continued to move sideways (2.5% YTD). Foreign equity inflows rose only marginally by USD0.2bn in June after falling USD2.9bn in May. Given the still challenging global economic environment, spreading of trade protectionism and lingering of geopolitical uncertainties, risk appetite in the KRW market would remain weak for the time being.  

    FX: Fed cut expectations fail to weaken the USD

    The US dollar Index (DXY) has appreciated 0.5% to 97.4 on the weaknesses of its major components, despite widespread expectations of an imminent rate cut. US data flow has been highlighting the USD’s relative advantage over the euro, which accounts for 57.6% of the weight in the DXY. The outlook for the Eurozone economy remains weighed by its largest economy, Germany. The ZEW current situation index turned negative in July for the first time since June 2010. If the ECB signals asset purchases at its next meeting on July 25, the euro will likley trade into the lower half of its 1.05-1.15 post-QE range.

    The British pound depreciated by 0.9% to 1.24 yesterday, below last December’s low at 1.25. The pound, which is the third largest (11.9%) component in the DXY, has lost 4.8% of its value this year to become the worst performing G10 currency. Boris Johnson, widely expected to become the Prime Minister next week, may be looking to prorogue parliament to push through a no-deal Brexit on October 31. Meanwhile, Brussels is unwilling to renegotiate the withdrawal agreement. A hard Brexit is now seen hitting the UK economy and pushing the Bank of England to ease monetary policy. The door is now open for the pound to trade lower towards its post-Brexit referendum low around 1.20.

    Ma Tieying

    Economist - Japan, South Korea, & Taiwan

    Philip Wee

    FX Strategist - G3 & Asia

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