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On June 19th, the U.S. Federal Reserve decided to leave its benchmark interest rate unchanged but hinted at possible rate cuts in the future. The Fed’s announcement indicates a significant shift from its previous stance of monetary policy. Here is Kim Dae-ho, director of the Global Economic Research Institute, to discuss the U.S. central bank’s growing inclination toward monetary easing. 

The U.S. Fed has held its policy rate at a range between 2.25 percent and 2.50 percent. The decision to freeze the rate was widely anticipated, though. What grabs more attention is that the Fed dropped the reference to “patient” in its statement. Previously, the inclusion of the word “patient” showed the Fed’s intention to not rush in adjusting the rate but to keep it frozen. Now, the New York Stock Exchange interprets the removal of the word from the statement as a sign that the Fed may lower the rate if necessary. 

The Federal Open Market Committee meeting last week shows that the Fed has turned even more dovish in its monetary policy stance. Although it kept the key interest rate unchanged, it signaled a clear shift in tone. This is well evidenced in the disappearance of the word “patient” from its statement and the inclusion of the phrase “act as appropriate to sustain the expansion” instead. Obviously, the Fed is ready to abandon the existing policy of rate freezes and switch to rate cuts. 

The U.S. continued to raise the interest rate for about four years to curb inflation caused by monetary loosening that was adopted in the wake of the 2008 global financial crisis. But many were concerned that continuing rate hikes might lead to a slowdown in the economy. U.S. President Donald Trump has been pressuring the Fed to lower the interest rate for the local economy. In fact, the U.S. economy, which had been faring quite well, began to show signs of tumbling last year, partly due to the trade war between the U.S. and China. As a preemptive move to cope with a possible economic downturn, the U.S. now looks poised to change monetary tightening that it advocated for the last five years.  

Behind the Fed’s shift in its policy stance, there are growing economic uncertainties coming from the protracted trade conflict between the U.S. and China. U.S. retail sales in April fell 0.2 percent from a month earlier, indicating that American consumers are tightening their purse strings. U.S. industrial output in April also declined 0.5 percent from the previous month, led by a 2.6 percent decrease in the production of motor vehicles and parts. Clearly, the U.S.-China trade dispute is affecting the American economy negatively. 

The so-called dot plot, which represents individual Fed policymakers’ expectations on interest rates, shows that the Fed is leaning toward rate cuts. 

The dot plot shows the anonymous, individual rate projections of Fed officials. Last week, their median rate forecast remained at 2.4 percent. Given the current federal funds rate of 2.25 to 2.5 percent, the latest projection shows that the Fed is unlikely to adjust the rate drastically, although it has suggested that it is prepared to cut rates. 

Members of the Federal Open Market Committee publish their forecasts for the key interest rate on a chart known as the dot plot. In the latest chart, only one official predicted a rate hike, while eight members projected a rate freeze. Seven members forecast two rate cuts this year, while one member indicated one cut. The dot plot result shows a high possibility of rate cuts within the year. The Fed may lower the interest rate as early as July unless the U.S. and China settle the trade dispute at their prospective summit later this month. The Fed’s possible rate cuts are expected to influence Korea’s own rate decision. 

The U.S. has suggested a major reversal in policy—from rate hikes to rate cuts, even though it did not lower the rate for now. The Fed’s move is giving Korea a headache. The Bank of Korea has raised its own key interest rate in line with the U.S. Fed’s rate increases. But now, the central bank of Korea has no reason for an additional rate hike. Moreover, many analysts are calling for a rate cut, citing the falling growth rate of the Korean economy. We have to wait and see what decision will be made at the Bank of Korea’s monetary policy committee meeting in July. Calls for rate cuts have already risen within the committee. In the local financial market, the interest rates of Treasury bonds and corporate bonds are lower than the central bank’s base rate, so Korea may cut the interest rate at an even faster pace than the U.S. 

The U.S. Fed’s rate decisions have great influence on Korea’s monetary policy. Those who are opposed to interest rate cuts have maintained that hasty cuts in Korea will only further widen the interest rate gap between the two countries. But this claim will lose ground if the U.S. lowers its interest rate. 

Also, experts are raising the need for economic stimulation via rate cuts, especially in light of the negative impact of the U.S.-China trade war on the global economy. Countries such as Australia and India have already taken preemptive action by lowering their interest rates. Keeping the recent developments in mind, Bank of Korea Governor Lee Ju-yeol has taken a step back from his previous hawkish position in support of rate hikes. 

Interest rate cuts are one of the policy options that governments may employ in order to revive the economy. The Korean government has already been carrying out an expansionary fiscal policy by submitting a 7 trillion-won extra budget bill. A rate cut in this situation may help boost the economy. 

Companies have two major sources of finance--shareholders’ equity, which is a net value of a company, and loans. Of course, companies have to pay interest on the loans. If the Bank of Korea lowers the key interest rate, businesses will pay less interest. The reduced interest cost alone will improve their balance sheets, even though their business conditions remain the same. 

Lower interest rates will also induce businesses to borrow more money from financial institutions and generate the effect of invigorating the economy. It will certainly have a positive effect of spurring the growth of the slowing Korean economy. 

Korea needs to take various factors into consideration when adjusting its key interest rate. For instance, an interest rate cut may increase the risk of accelerating the growth of Korea’s household debt that has now exceeded 1,500 trillion won or roughly 1.3 trillion US dollars. For now, the result of trade negotiations between the U.S. and China will likely determine the direction of interest rate decisions.