Trade war pressures South Korea to cut rates faster and deeper

By Cynthia Kim

SEOUL (Reuters) - South Korea's central bank may be forced to bring forward or deepen interest rate cuts this year as Asia's fourth-largest economy grapples with the risk of recession due to the escalating U.S. trade war.

Until recently, the Bank of Korea was expected to make two quarter-point cuts in the benchmark interest rate for the remainder of the year - one in the second quarter and another in the third.

The global market meltdown and drastic changes to the outlook brought on by tariffs now mean the bank's next cut could come as soon as next week with even deeper easing likely to be needed to revive a struggling economy in the months ahead.

Citi Research on Monday brought its projection forward for the next BOK rate cut to April 17 from May 29, while ING on Friday also said it may bring forward its forecast for a cut to next week from May.

The increasingly dovish rate expectations come as central banks shift their policy focus to supporting economic activity, away from immediate concerns about inflation or currency stability. Policy decisions in New Zealand, India, the Philippines and Singapore are due over the coming week with all their central banks expected to ease monetary settings.

"We are reassessing downside risks to growth this year due to the 25% tariff announced last week as well as the fallout expected from all the retaliatory measures," said an official familiar with the BOK's thinking, referring to U.S. President Donald Trump's sweeping tariffs last week and the BOK's revised quarterly outlook due in May.

"Depending on how we review this downside risk, it's possible to adjust the pace of easing," said the official, who asked not to be named due to restrictions on talking to media.

South Korea was slapped with a 25% tariff on exports to the United States, among the highest imposed on a security ally, amid pressure from Washington to slash its $55.7 billion trade deficit with the Asian factory powerhouse.

The tariff blow comes at a sensitive time for South Korea, which is dealing with a leadership vacuum after months of political turmoil.

Yoon Suk Yeol was removed from office last week, four months after his failed bid to impose martial law, which has left the economy without clear policy direction.

The political crisis also came as Korea Inc. faces increasing pressure to raise U.S.-bound investment and relocate production to America.

Finance minister Choi Sang-mok said on Tuesday U.S. tariffs will deal a "huge blow" to South Korean exporters including those with production in Vietnam and elsewhere, as weakening demand threatens the trade-reliant economy.

The BOK cut rates in February, its third reduction since it started pulling rates away from a 15-year high in October. Government bond pricing suggests investors expect further easing.

The yield on the policy-sensitive three-year government bond fell to 2.405% from 2.569% at the end of March.

The BOK is expected to further downgrade its economic growth forecast this year after cutting it to 1.5% in February from 1.9% previously.

Economists agree that the impact of the tariffs and the market upheaval they have unleashed may open the door to deeper rate cuts by the BOK.

"The estimated negative impact of tariff shocks on both economic growth and inflation suggests a sharper rate cutting cycle," Citi research economist Kim Jin-wook said. He expects cumulative cuts of around 150 basis points by the end of 2026, or six 25 bps cuts to 1.25% from the current 2.75%.

While currency pressures pose some constraint to central banks, economic growth is now expected to remain a priority.

The won was one of Asia's worst performing currencies last year and made its sharpest daily decline against the dollar in five years on Monday. It was trading at 1,472.3 per dollar on Tuesday.

"The greenback is gaining amid inflation concerns and the flight to safety, which leaves the won under downward pressure," Lee Seung-heon, former senior deputy governor of the BOK, said. "Having said that, policymakers also need to consider growing downside risks to the economy."

(Reporting by Cynthia Kim; Additional reporting by Jihoon Lee Editing by Ed Davies and Sam Holmes)