US lowers interest rates for the first time in 4.5 years

The U.S. Federal Reserve (Fed) lowered its benchmark interest rate by 0.5 percentage points at once. It was the first rate cut since March 2020, at the height of the COVID-19 pandemic. As the Fed joins the European Central Bank (ECB), the United Kingdom, and others who have already started cutting rates, it is expected to accelerate the pace of global rate cuts. South Korea should also consider lowering interest rates to respond to sluggish domestic demand, but soaring housing prices and ballooning household debt are holding it back.

As the Fed’s monetary policy reorientation was predicted, global financial markets have been focusing on the extent of the rate cut. With the Fed’s decision to make a “big cut,” the U.S. benchmark interest rate fell to 4.75 to 5.0 percent per year. The Fed also hinted at the possibility of two more cuts later in the year. The 4.5-year war on inflation in the wake of the pandemic is finally over.

While interest rate cuts, which have been long-awaited by indebted households and businesses, began, South Korea is in a tricky position to simply welcome the new change. The gap between South Korea’s 3.5 percent benchmark interest rate and that of the U.S. has narrowed to 1.5 percentage points, reducing concerns about a foreign capital flight.

Consumer price inflation was also in line with the Bank of Korea’s target of 2.0 percent last month. The problem is that unlike advanced economies such as the U.S., where households and other economic players have reduced their debt during interest rate hikes, South Korea has failed to restructure its debt.

In particular, household debt surged to a record high last month due to repeated policy errors by the government, including expanding low-interest policy loans and delaying the regulation of the debt service ratio (DSR). Much of the increased debt has gone into real estate, with apartment prices in Seoul rising for 24 consecutive weeks. Although loan growth slowed last month as the financial authorities pressured banks on all fronts, the “alienation phobia” and willingness to buy a home is still at an all-time high among potential home buyers. If the Bank of Korea decides to lower interest rates to stimulate domestic demand, it could fuel the fire, further worsening the excessive loan growth. The increased debt will further reduce households’ spending power, likely reducing economic growth.

Nevertheless, the government interpreted the Fed’s decision as a “signal of the end of the global multi-crisis” and indirectly pressed for a rate cut, saying it would center its economic policy on revitalizing domestic demand. For the Bank of Korea to initiate a rate cut in October, it must fulfill prerequisites such as substantial expansion of apartment supply in Seoul and nearby regions and control over speculative real estate lending. The government’s impatience shouldn’t lead to further inflation of a dangerously inflated debt bomb.