'Won' Falls More Than Ruble... Is the Korea-US Interest Rate Gap Okay?

Won posts largest decline against dollar among major currencies
Won-dollar exchange rate surges amid ongoing US tightening concerns
Interest rate gap between Korea and US expected to widen... Bank of Korea faces 'dilemma'

The value of the Korean won against the dollar has fallen nearly 7% just this month. This is the largest depreciation among major currencies, including the Russian ruble, which is under Western sanctions. With the Bank of Korea recently holding the base interest rate steady, and the U.S. Federal Reserve (Fed) expected to maintain a tight monetary policy for a considerable period, there is analysis suggesting that the widening interest rate gap between Korea and the U.S. could increase upward pressure on the won-dollar exchange rate.

On the 27th, in the Seoul foreign exchange market, the won-dollar exchange rate closed at 1,323.0 won, up 18.2 won from the previous trading day. The exchange rate showed an upward trend from the opening, recording 1,315.0 won, and during the session surpassed 1,320 won, continuing its high-level rally. This is the highest level in about three months since December 8 last year, when the high was 1,323.3 won. Considering it had fallen to 1,216.4 won on the 2nd of this month, it surged more than 100 won in less than four weeks.

The won has also shown a steep depreciation compared to other major currencies. As of the afternoon of this day, it had fallen 6.89% this month, marking the largest depreciation. During the same period, the ruble fell by 6.65%, the Japanese yen by 4.53%, the British pound by 3.23%, the euro by 3.08%, and the Chinese yuan by 3.04%. Even after last week's Bank of Korea Monetary Policy Committee meeting, the won has fallen 1.96%, showing the steepest decline among major currencies.

The recent sharp rise in the won-dollar exchange rate is due to the dollar's strength amid ongoing U.S. inflation shocks, but expectations of won weakness also played a role. With continued trade deficits due to sluggish exports and analyses suggesting that China's reopening (resumption of economic activities) is less likely to provide significant support as before, the won's weakness against the dollar has been further encouraged.

According to the Bank of Korea's analysis, China's reopening positively affects the Korean economy through recovery in exports to China and increased inflow of Chinese tourists. However, since China is recently showing recovery centered on consumer goods rather than investment goods, and signs of inventory accumulation and weak external demand are emerging, the domestic growth-enhancing effect is likely to fall short of the past average.

Park Sang-hyun, a researcher at Hi Investment & Securities, explained, "The simultaneous weakness of the yuan and yen, which show high correlation with the won, along with the Monetary Policy Committee's rate freeze, has strengthened expectations of won weakness." Although the possibility of a sharp won plunge like when the won-dollar exchange rate soared past 1,400 won last year is low, if the exchange rate continues to rise, the herd behavior of importers chasing purchases and exporters taking a wait-and-see stance could intensify, further increasing exchange rate volatility.

In fact, last year, amid the global dollar strength trend, the won's value declined more steeply than other major currencies, increasing capital outflow pressure and causing herd behavior in the foreign exchange market. Bank of Korea Governor Lee Chang-yong said at a press conference after the February Monetary Policy Committee meeting, "At the end of last year, the variable of the exchange rate came in and shook the financial market," adding, "(Therefore) we were forced into a situation where we were not independent from the Fed and had to follow it."

Jerome Powell, Chairman of the Federal Reserve (Fed)
[Photo by Yonhap News]

As analysis suggests that the interest rate gap between Korea and the U.S. could widen up to 2 percentage points, the Bank of Korea's dilemma is expected to grow. For now, the Bank of Korea intends to keep the base rate steady at 3.5% per annum and observe the ripple effects of previous rate hikes, but the Fed is expected to raise its base rate to 5.25?5.50% by June this year. Jamie Dimon, CEO of JPMorgan Chase, recently said, "U.S. interest rates could reach 6%."

Governor Lee maintains the position that "there is no appropriate level for the Korea-U.S. interest rate gap," but if the gap widens further and pressure on the exchange rate or capital outflows increases, the Bank of Korea may consider the option of raising rates. Professor Heo Jun-young of Sogang University's Department of Economics said, "Since the Fed has stated it will not lower rates until the end of this year, the Korea-U.S. interest rate gap could widen to 1.75?2 percentage points, and how we endure this is crucial."

Professor Heo added, "However, considering the recent economic slowdown and real estate market slump in Korea, it is indeed difficult for the Bank of Korea to raise rates further," and said, "For now, it seems best to endure through foreign exchange reserves or after-the-fact measures while hoping for positive turns in U.S. economic indicators such as inflation, unemployment, and employment rates."

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