Bank of Korea keeps rates steady as it assesses measures to cool Seoul's housing market

• The Bank of Korea noted a “significant acceleration in housing prices in Seoul.”
• The central bank is, however, expected to cut rates in its next policy meeting as measures to cool the housing market in Seoul take effect.
• Household debt in South Korea plays a huge part in the central bank's monetary policy considerations, due to the country's unique rental system.

South Korea's central bank held its policy rate at 2.5% Thursday, as it assesses the impact of recent measures aimed at cooling Seoul's housing market.

Housing prices in Seoul spiked over 19% in June on an annualized basis, according to Goldman Sachs, prompting financial authorities to step in with measures to address rapidly expanding household loans.

The Bank of Korea noted a “significant acceleration in housing prices in Seoul and its surrounding areas, [as well as] household debt.”

The central bank had lowered rates in its last policy meeting in May at a time when the country was in the midst of a political turmoil while also facing steep tariffs on auto and steel exports from the U.S.

While South Korea's economy contracted by 0.2% quarter on quarter in the first three months of this year amid softening exports growth and weak construction activity, the bank chose to keep rates steady, prioritizing financial stability over growth concerns.

BOK said it was critical to evaluate the effect of macro policies given the rise in risks associated with the housing market in Seoul and rising household debt, while also “remaining cautious about the possibility of heightened volatility in the foreign exchange market.”

Goldman said in a note last week that recent housing market developments had heightened the BOK's concerns about financial stability, adding that household loan growth surged to 6 trillion won ($4.27 billion) in May — the fastest pace since last October — and is estimated to have reached 7 trillion won in June.

“The housing market in Seoul and its surrounding areas, which had previously shown signs of overheating, appears to be stabilizing somewhat following the implementation of the government's household debt measures,” the BOK said Thursday.

The central bank is, however, expected to cut rates in its next policy meeting as measures to cool the housing market in Seoul take effect. Goldman said that the introduction of new mortgage lending restrictions would “open the door” for a rate cut in the BOK's August meeting.

South Korea faces economic headwinds as U.S. President Donald Trump has threatened to impose 25% tariffs on all South Korean imports starting Aug. 1, if the country fails to reach a trade deal with Washington.

South Korea's Kospi was up 0.74%, while the won strengthened marginally to trade at 1,372.48 against the dollar.

High debt from housing

Household debt in South Korea plays a huge part in the central bank's monetary policy considerations, due to the country's unique rental system.

Unlike most rental systems around the world, South Korean renters pay a deposit known as “jeonse” or “key money,” instead of a monthly rent to landlords.

The jeonse is a deposit about 50%-80% of the market value of the property. At the end of their lease, the deposit is returned to the renter. For the landlord, the jeonse is an interest-free loan, which they are free to invest.

However, renters will usually take out a loan to fund the jeonse deposit, which causes “a lot of burden and excess debt in the system for housing,” Samuel Rhee, co-founder, chairman and group chief investment officer for wealth platform Endowus told CNBC.

Park Jeongwoo, Nomura's economist for South Korea and Taiwan, told CNBC earlier this year that the BOK was concerned about the negative long-term impact of higher household debt on growth.

“The BOK thinks [the] higher debt burden has weakened households' spending power. At the same time, strong debt-financed demand for housing [has] resulted in distorted capital allocation across the economy, leading to more allocation of capital to not-productive sectors.”