Exchange Rate Nearing 1400 Won... Bank of Korea Faces Deepening Dilemma Over Big Step

Cautious Stance Amid Rapid Interest Rate Hikes
If the US Takes a Giant Step or More,
Interest Rate Gap Between Korea and the US Widens Significantly

On the 14th, when the U.S. stock market plummeted due to inflation fears, the won-dollar exchange rate and the KOSPI were displayed in the dealing room of Hana Bank in Euljiro, Seoul. On that day, the exchange rate surpassed 1,390 won for the first time in 13 years and 5 months. Photo by Moon Honam munonam@

[Asia Economy reporters Seo So-jeong, Son Seon-hee in Sejong, and Moon Je-won] Following the shock from the U.S. Consumer Price Index (CPI) for August, expectations have risen that the U.S. Federal Reserve (Fed) will accelerate its benchmark interest rate hikes, causing the won-dollar exchange rate to soar and the stock market to plunge on the 14th, amplifying the ripple effects in the domestic market. As the Fed’s ultra-tight monetary policy is expected to further weaken the Korean won, increasing the burden on the Korean economy, voices are growing for the Bank of Korea to also implement a ‘big step’ (a 0.50 percentage point increase in the benchmark interest rate).

According to the financial market on that day, after the release of the U.S. August CPI, the possibility that the Fed will maintain a higher interest rate level for a considerable period has increased, shaking the domestic foreign exchange and securities markets. Currently, Korea’s benchmark interest rate is 2.50%, and the U.S. benchmark rate is 2.25?2.50%, with the upper limit being the same. If the Fed carries out at least a ‘giant step’ (a 0.75 percentage point increase in the benchmark interest rate) at this month’s Federal Open Market Committee (FOMC) meeting as the market expects, the interest rate gap between Korea and the U.S. will widen immediately.

While analyses suggest that the Fed will raise its benchmark interest rate to 4.0?4.5% in response to inflation, the Bank of Korea is still maintaining a gradual increase policy of 0.25 percentage points, making it highly likely that the interest rate gap between Korea and the U.S. will widen further after the end of the year. Given the recent significant upward pressure on prices from both demand and supply sides and the unstable import prices due to the rising exchange rate, if the won weakens rapidly, the rise in prices and exchange rates could explode into a serious problem.

Accordingly, among experts, opinions are emerging that the Bank of Korea should also take a big step again. Professor Sung Tae-yoon of Yonsei University’s Department of Economics pointed out, "The necessity for a big step has already increased," adding, "Our authorities are sending signals to the market that raising interest rates is not easy, which is causing our currency value to fluctuate significantly and the foreign exchange market to become unstable."

The Bank of Korea also agrees with raising interest rates but appears somewhat cautious about rapid hikes. According to the minutes of the Monetary Policy Committee meeting held on the 25th of last month, released the day before, the members stated that "it is necessary to continue the interest rate hike trend," but expressed concerns about the expanding downside risks to the domestic economy and mentioned that "the speed and extent need to be carefully controlled."

On that day, as fears of U.S. tightening spread, the won-dollar exchange rate surged to the 1,390 won level. Securities firms forecast that, ahead of next week’s U.S. FOMC, with heightened caution about tightening and the absence of domestic and external factors supporting won strength, the year-end exchange rate ceiling should be opened up to 1,500 won. Moon Hong-chul, a researcher at DB Financial Investment, said, "The U.S. inflation shock has strengthened the view that the Fed will continue strong tightening, intensifying the dollar’s strength," adding, "Market volatility is expected to expand further until next week’s U.S. FOMC, and if a recession crisis also arrives by year-end, the exchange rate could rise to 1,500 won, which cannot be ruled out."

Kwon Ah-min, a researcher at NH Investment & Securities, said, "With U.S. inflation still confirmed to be high, the Fed is expected to continue its tightening stance, and combined with the winter euro weakness, the global strong dollar phenomenon is expected to persist until year-end," adding, "The first resistance level is judged to be 1,420 won, and the year-end exchange rate ceiling is revised upward to 1,450 won." In particular, Korea’s August trade balance recorded the largest monthly deficit, and the possibility of an overall current account deficit in August has also been raised, acting as a factor weakening the won. Kim Jung-sik, emeritus professor of the Department of Economics at Yonsei University, expressed concern, saying, "If the fiscal balance is in deficit and the current account also turns to deficit, it becomes a ‘twin deficit,’ lowering Korea’s economic credibility and potentially triggering avoidance sentiment toward the won."

The government, judging that market uncertainty is increasing, decided to review related countermeasures. On the morning of that day, Bang Ki-seon, First Vice Minister of Strategy and Finance, chaired an unscheduled emergency economic task force (TF) meeting and urged, "Please thoroughly review all available countermeasures to stabilize the market." Vice Minister Bang diagnosed, "Uncertainty about the magnitude and speed of interest rate hikes by major countries is increasing, raising volatility in domestic and international financial markets," and emphasized, "While paying attention to global inflation and the schedule for monetary policy normalization, please maintain special vigilance and closely monitor the financial and foreign exchange market situation."

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