A virus that has killed seven South Koreans and put almost 3,000 in quarantine is bolstering the case for lower interest rates.
The spread between three-month certificates of deposit (CD) and similar-term CD forward contracts widened to minus-19 basis points yesterday, near the average of minus-20 seen the day before rate cuts in March, and October and August last year. Citigroup Inc and Morgan Stanley expect a cut tomorrow, and JPMorgan Chase & Co by July as the Middle East respiratory syndrome (MERS) threatens growth.
Ten of 18 economists see the Bank of Korea easing on Thursday.
Asia’s fourth-largest economy might need support as the south’s Korea Tourism Organization estimates that more than 40,000 people have canceled visits, about 2,200 schools are shut and Hyundai Motor Group has suspended official events because of the disease. A rate reduction would also help reverse the won’s rally to a seven-year high against the yen, which business groups say is making it tougher to compete as exports drop.
“MERS can affect sentiment and worsen consumption and investment, so better to cut rates earlier than later,” said Chang Jae-chul, a Seoul-based economist at Citigroup. “With the overall export situation not good, there’s a need to stimulate domestic demand.”
Bank of Korea (BOK) Governor Lee Ju-yeol said last month that while export sluggishness is not confined to South Korea, it has a big impact given the economy’s reliance on overseas sales. The won has risen against 23 of 31 major currencies in 12 months. Its 10 percent jump to 8.99 per yen is hurting shipments the most, while Japanese companies benefit.
The Federation of Korean Industries on May 29 became the third business group in a week to call on the South Korean government to halt the won’s advance. Exports fell the most in six years last month, while those from Japan rose.
ING Group NV last week compared the potential MERS fallout to the 2003 outbreak of severe acute respiratory syndrome (SARS) in Hong Kong, and brought forward its rate-cut call to this month from next month. SARS infected 1,755 people in Hong Kong, killing 300, and caused US$490 million of economic losses in two months as tourist arrivals dwindled and residents stayed at home.
While rate-cut calls are rising, opposing views are still strong. Of 27 analysts surveyed from May 15 to May 20, 12 predicted the benchmark rate would be lowered by 25 basis points from a record-low 1.75 percent this year. Fourteen forecast no change and one predicted an increase.
Barclays PLC and Hyundai Securities Co predict no change at this week’s meeting, saying that to cut the rate further, the central bank would need to be convinced the MERS outbreak would reduce growth this year to less than its 3.1 percent forecast.
Three-year government bonds yielded 1.74 percent yesterday, and HI Investment & Securities Co said it is not falling further on concern that the Bank of Korea’s easing cycle might be coming to an end.
MERS is the latest setback to an economy that has been grappling with weak consumption since the sinking of the Sewol ferry in April last year wrecked domestic spending.
“South Korea is relying on domestic demand for growth and MERS can have a negative impact, like the Sewol ferry sinking did, leading to a rate cut,” said Lim Ji-won, a Seoul-based economist at JPMorgan. “As for the timing, July seems more feasible than June, as the BOK will need time to monitor the economic impact of the outbreak.”
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