South Korean industrial production drops, yet BoK likely on hold until fourth quarter

South Korea’s all-industry output showed a sharper contraction in May. Output in manufacturing (-2.9%), construction (-3.9%), and services (-0.1%) sectors declined, whereas public administration output was the exception, rebounding (0.8%).

We expected mining and manufacturing industrial production to drop given the weak May exports. But the outcome (-2.9%) was weaker than our forecast (-0.5%) and market consensus (0.5%).

Semiconductors dropped -2.0 % for the second month following a sharp rise (12.3%) in March. Shipments rebounded meaningfully (14.9%), mostly for exports. We believe global demand for chips is still solid, but chip makers are holding inventories tight given the uncertainty surrounding the US trade policy. Inventory levels have dropped continuously from the end of 2024, falling nearly to 2020 levels. This eventually should work in favour of chip output in the coming months.

For the vehicles, output dropped by -2.3% in May, after a -4.1% decline in April. We think the US 25% tariffs on auto and auto parts have negatively impacted auto sector output. Weakening demand for electric vehicles and the increase in production at US plants also should weigh on the auto sector. Inventories edged down in May, but overall levels have risen since July 2024. Sluggish auto sector output is expected to continue for an extended period.

Meanwhile, services output edged down by 0.1% month on month, seasonally adjusted, for a second month. Financial services (2.8%) rose, while telecommunications (-3.6%) and transportation (-2.4%) dropped.

Durable goods (1.2%) and semi-durable goods (0.7%) rose while non-durable goods dropped (-0.7%). We believe that the introduction of new mobile phone models and government tax incentives for car purchases likely boosted retail sales. Consumer sentiment recovered quite sharply over the past two months, while high-frequency data also improved recently. We expect retail sales to improve in the coming months, supported by lower interest rates and government aid.

Equipment investment declined -4.7% MoM, seasonally adjusted, in May, marking the third consecutive month of decline. This poses a significant downside risk to the current quarter’s growth forecast. However, we anticipate a rebound based on positive forward-looking data. The increase in capital goods imports is expected to positively impact equipment investment. Machinery orders rebounded in a three-month comparison. Lastly, the government is expected to increase spending on infrastructure and facility investment. This should support solid investment growth.

Construction investment also dropped -3.9% MoM, seasonally adjusted, in May, marking declines in 10 of the last 12 months. We believe construction investment will drag on the domestic economy for some time. The construction sector in non-Seoul areas has been undergoing restructuring and is expected to stabilize in the second half of the year.

We believe that the economy has already hit bottom and will rebound in the current quarter. Yet, today's weaker-than-expected IP data poses downside risks to our current GDP forecast of 0.4% quarter on quarter, seasonally adjusted. The downside surpises mainly came from weak equipment investment. However, several forward-looking indicators suggest a recovery in the near term. Thus, we believe facility investment is likely to rebound, but to a smaller degree than the previously expected. Consumption was also weaker than expected, staying flat. But, given the strong rally in local equity market and the government fiscal support, we believe consumption could rebound in the coming months. On the other hand, exports in June are expected to rebound smartly. Sharper declines in imports are likely to contribute positively to net export growth. After tomorrow's export data, we will adjust our GDP forecasts accordingly.

Weaker-than-expected IP data should keep the BoK's easing cycle alive. Yet, the recent surge in housing prices and household debt will make the central bank more cautious. Strong mortgage measures, recently announced by government, will eventually stabilize the housing market, but the data will only be confimed by September. We expect the BoK to take a wait-and-see approach in the third quarter, then deliver a 25 bp cut in October.