The dichotomy between falling exports and recovering domestic demand in South Korea

The trade and production data are due tomorrow. It has been reported that exports contracted 7.0% (YoY) in the first 20 days of Sep15, a smaller decline compared to -12.1% in the same period of Aug15. But the full-month figures would remain weak at about -10%, taking into account the late arrival of the Chuseok festival this year. Industrial production, which is reported for Aug15, is likely to continue shrinking on both YoY and MoM basis. Sluggish trade and production data are expected to put depreciation pressures on the Korean won, especially against the backdrop of a broadly strong USD and low risk appetite in the global financial markets. 

Notwithstanding the weakness in the external sector, the domestic economy has remained in a recovery mode. The central bank's two rate cuts so far this year have generated positive effects, boosted credit growth and revived the property market. As the disruption impact of the Middle East Respiratory Symptom (MERS) faded, consumer confidence has also started to recover. Given the additional supports from the government's supplementary budget and the temporary cut of consumption tax, the rising trend in domestic demand should remain intact in 2H15. 

While the bond market continues to look for a rate cut from the Bank of Korea (BOK), this chance is low. There is no strong need for the BOK to cut rates to further lift domestic demand - unless external headwinds intensify and the overall growth path is derailed. In addition, inflation numbers have started to pick up as the favorable base effects dissipated. Friday's data will likely show that headline CPI has returned to the 1% level in Sep15, which should limit the room for the BOK to cut rates from an already low 1.50%.