Despite BoK Rate Hike... Korean Won Declines More Than Ultra-Low Interest Rate Japanese Yen

Won-Dollar Exchange Rate Surpasses 1,357 Won, Yen at 140 Yen
Both Won and Yen Plummet Amid Strong Dollar
However, Since July, Won Declines More Than Yen
Trade Deficit and Concerns Over Korea's Economic Slowdown Grow
Japan Maintains Ultra-Low Interest Rates, Korea Raises Rates 'Opposite Directions'

Despite the global financial markets being rocked by a strong dollar causing major currencies to plummet one after another, the depreciation of South Korea's won has been particularly severe. The Bank of Korea has continued its monetary tightening policy by raising the benchmark interest rate four consecutive times for the first time ever until last month, but the won has been struggling even more than the Japanese yen, which is maintaining an ultra-low interest rate policy. Due to the heightened preference for safe-haven assets amid the US-China conflict and the widening trade deficit at home, concerns are emerging that the won's downward trend could accelerate.

Both Won and Yen Plunge Amid Strong Dollar

According to the Seoul foreign exchange market on the 2nd, the won-dollar exchange rate has recently been hitting new highs consecutively, pushing the upper limit higher. After surpassing 1,355 won per dollar the previous day, it broke through 1,357 won on the same day, approaching the 1,360 won level. The Japanese yen, which is in a similar situation to South Korea, has also recently fallen to the 140 yen level, rewriting its lowest record since 1998. Due to global inflationary pressures, most countries including the US and Europe have raised benchmark interest rates, but Japan has continued its accommodative monetary policy alone, intensifying the yen sell-off.

The problem is that the depreciation of South Korea’s currency has been more pronounced recently than Japan’s, which maintains an ultra-low interest rate policy. Looking at the cumulative figures for this year until the previous day, the yen has fallen 17.91% against the dollar, and the won has fallen 12.26%, showing a larger decline in the yen. However, since July, the won’s depreciation has accelerated. Especially after the Bank of Korea’s Monetary Policy Committee implemented a ‘big step’ (a 0.50% increase in the benchmark interest rate) for the first time in history on July 13, the won has fallen 3.54%, a larger decrease than the yen’s 2.02%.

On the 2nd, the KOSPI opened at 2,427.7, up 12.09 points (0.5%) from the previous trading day, at the Hana Bank dealing room in Jung-gu, Seoul. The won-dollar exchange rate started at 1,356.0, up 1.1 won. Photo by Hyunmin Kim kimhyun81@

Direct Hit from Trade Deficit... Won Struggles

Since the US Federal Reserve (Fed) is rapidly raising benchmark interest rates to curb inflation, depreciation of both the won and yen is inevitable. However, in South Korea’s case, the recent accumulation of trade deficits has created an atmosphere where currency weakness is more severe compared to other countries. Because South Korea is highly dependent on exports, a growing trade deficit is interpreted as a sign of slowing economic growth, which fuels the decline in the won’s value. In fact, on the day statistics were released showing that last month’s trade deficit reached $9.47 billion, the largest monthly deficit since 1956, the won plunged 1.28%, suffering a bigger blow than the yen’s 0.88% drop.

Additionally, the weakening of the Chinese yuan, which is strongly correlated with the won, is also pushing up the won-dollar exchange rate. The yuan has been struggling recently due to a combination of COVID-19 lockdown measures, sluggish Chinese real estate market conditions, intensified US-China tensions, and insufficient economic stimulus policies by the Chinese government. The Bank of Korea analyzed, "The won is weakening due to concerns about a Chinese economic downturn, escalating geopolitical tensions between China and Taiwan causing yuan depreciation, and South Korea’s persistent trade deficits."

Haruhiko Kuroda, Governor of the Bank of Japan, attended the House of Councillors plenary session in Tokyo on June 13 and responded to questions from lawmakers. Governor Kuroda stated that the sharp decline in the value of the yen is negative for the economy and undesirable, and that he will closely monitor trends in the foreign exchange market.
[Image source=Yonhap News]

Contrasting Responses from Bank of Korea and Bank of Japan... What Lies Ahead?

While both the won and yen are depreciating amid the strong dollar environment, the responses of the central banks of South Korea and Japan are completely different. The Bank of Korea has raised the benchmark interest rate seven times by a total of 2 percentage points since August last year, whereas the Bank of Japan (BOJ) has maintained a negative 0.1% benchmark interest rate since January 2016. At the recent Jackson Hole meeting held in Wyoming, Lee Chang-yong, Governor of the Bank of Korea, reaffirmed the rate hike stance, but Haruhiko Kuroda, Governor of the Bank of Japan, emphasized a unique path by stating, "We have no choice but to maintain accommodative monetary policy."

It is analyzed that Japan finds it difficult to abandon accommodative monetary policy due to its substantial debt and prolonged deflation. However, concerns about yen depreciation within Japan are not absent. As the yen-dollar exchange rate broke below the psychological resistance level of 140 yen, voices are emerging that Japan might fall into a ‘vicious cycle of yen depreciation.’ The concern is that if the trade deficit widens due to yen depreciation, yen selling will expand, which could further lower the yen’s value.

If the yen depreciation continues amid the current situation where raw material and energy prices have surged due to Russia’s invasion of Ukraine, Japan’s trade deficit is expected to widen further. If the foreign exchange market falls into such a vicious cycle, it will be difficult to improve the economic recession without government intervention. Previously, in 1998, when the yen surged to 147 yen, the Japanese government artificially intervened in the foreign exchange market.

The future value of the won and yen is expected to depend on the pace of the Fed’s rate hikes and the economic recession situation. Lee Ji-pyeong, a special lecturer at Hankuk University of Foreign Studies, said, "The yen’s weak trend will also change depending on how the US rate hikes and economic slowdown unfold until early next year," adding, "However, it seems unlikely that the yen will fall to 150 yen against the dollar."

This content was produced with the assistance of AI translation services.