Bank of Korea keeps interest rates unchanged at 3%

The Bank of Korea unexpectedly kept its benchmark policy rate at 3% on Thursday, choosing to assess changes in domestic and foreign economic conditions after cutting interest rates twice in a row at previous meetings.

Economists polled by Reuters expected a 25 basis point rate cut.

The Bank of Korea said in a statement that while inflation has stabilized and household debt has slowed, “downside risks to economic growth have intensified due to the recent unexpected escalation of political risks and exchange rate volatility has increased.”

The bank also said uncertainty had also increased due to “changes in domestic political situations and economic policies in major countries.”

The Bank of Korea's move comes amid political turmoil in the country, with impeached President Yoon Seok-yeol being arrested on Wednesday, the first time a sitting South Korean president has been arrested.

After the decision was announced, South Korea's Kospi rose 1.25% and the small-cap Kosdaq rose 1.69%. The South Korean won gained about 0.3% to 1,450.27.

Alex Holmes, head of Asia research at the Economist Intelligence Unit, told CNBC's “Squawk Box Asia” immediately after the decision was made that it was a “very tricky” decision for the bank .

“I mean, on the one hand, the economy wasn't necessarily doing very well even before all this political uncertainty. Yes, there are certain areas of the export industry that are very, very hot. You know, chips, semiconductors, electronics product, but other exports have really underperformed,” Holmes said.

“Realistically, the domestic economy is struggling to gain momentum. So it's a very dovish backdrop for growth, but at the same time it has to be balanced by the fact that the currency has sold off very clearly,” he added.

Holmes added that the South Korean won has fallen more than the Japanese yen since early October, even though the Bank of Korea's interest rate spread is smaller compared to the Fed.

At the same time, Holmes noted that 2024 is the first year that household debt as a percentage of GDP declines, and the Bank of Korea does not want to cut interest rates too quickly to stem the rebound.

The Bank of Korea said in a statement that it is “highly likely” that South Korea will not meet the Bank of Korea's full-year GDP growth forecast of 2.2% in 2024 and 1.9% in 2025.

“Export growth is expected to slow and domestic demand will recover slower than expected as consumer confidence deteriorates,” the central bank added.

The Bank of Korea noted that while export growth “increased” in December, the recovery in consumption weakened and construction investment “remained sluggish.”

In addition, the central bank said that “there remains high uncertainty about the future economic growth path” due to domestic politics, economic stimulus measures and policy changes from the incoming Trump administration.