Exchange Rate Surpasses 1,500 Won...2% Growth Target Shaken by Middle East Shock

The value of the Korean won breaking through the 1,500 won level can immediately impact the Korean economy by leading to higher import prices and increased energy costs. A simultaneous surge in international oil prices and the won-dollar exchange rate acts as a multi-layered negative factor, driving up production costs such as various raw material prices and logistics expenses, and in turn, fueling consumer prices. There are concerns that a complex set of risks that could shake prices, interest rates, and the stock market as a whole has materialized. These high oil prices and high exchange rates are variables beyond the government's control, making the government’s goal of achieving a growth rate in the 2% range this year increasingly uncertain.

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The combination of oil prices surpassing 80 dollars per barrel and a high exchange rate is further driving up import prices. During the overnight session the previous day, the won-dollar exchange rate temporarily broke through the 1,500 won mark, sounding an alarm for rising import prices. Domestic import prices have been on an upward trend recently. According to the Bank of Korea, last month’s import price index was 143.29, up 0.4% from the previous month, marking a seven-month consecutive increase. Although there was a slight year-on-year decrease, upward pressure persisted due to the high exchange rate trend that has continued since October last year. The rise in import prices typically pushes up domestic consumer prices with a lag of one to three months. Last month, South Korea’s consumer price inflation rate slowed to 2.0%, the lowest in five months. The decline in oil prices due to expanded supply played a key role in stabilizing consumer price inflation in recent months.

The steep rise in the exchange rate could act as a major negative factor for domestic demand. Shin Sedon, Professor of Economics at Sookmyung Women’s University, pointed out, "If the value of the won collapses while international oil prices are surging, import prices are bound to rise," and added, "If this leads to a chain reaction of rising consumer prices, consumption will shrink further and stagflation-where economic stagnation and inflation occur simultaneously-could emerge.” He also noted that the government’s plan to boost this year’s growth rate to 2% through domestic demand may face setbacks.

Despite the decline in international oil prices, import prices continued to rise for the fourth consecutive month due to the increase in exchange rates. The photo was taken on the 14th at Mangwon Market, Mapo-gu, Seoul. Photo by Jin-Hyung Kang aymsdream@

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Amid growing concerns about inflation due to the simultaneous rise in the exchange rate and oil prices, government bond yields surged across all maturities. On March 3 (local time), the U.S. 2-year Treasury yield closed at 3.18%, up 13.9 basis points (1bp=0.01 percentage point) from the previous session. The 5-year and 10-year U.S. Treasury yields rose by a similar margin, reaching 3.59% and 3.65%, respectively. As U.S. Treasury yields increased, Korean government bond yields climbed as well. In the Seoul bond market the previous afternoon, the 3-year Korean Treasury bond yield closed at 3.180%, up 13.9 basis points from the previous session.

If interest rates rise while prices are already increasing due to simultaneous spikes in the exchange rate and oil prices, this could sharply dampen private consumption sentiment due to deteriorating economic sentiment among market participants. Some experts point out that if the Middle East crisis persists, the ripple effects could lead to stagflation, where economic stagnation and price increases occur simultaneously. Lee Yoonsu, Professor at the Graduate School of International Studies at Seoul National University, stated, "If the high exchange rate continues, it could result in a triple blow of inflationary pressure, slower growth, and financial instability."

Authorities are closely monitoring exchange rate fluctuations and external conditions, maintaining a 24-hour monitoring system. A government official said, "The weakening of Asian currencies, which have relied on Middle Eastern oil, is becoming more pronounced, and if the situation drags on, further declines are expected," adding, "If market instability intensifies, we plan to swiftly activate the response measures already in place."

As of 9:11 a.m. on the day of publication in the Seoul foreign exchange market, the won-dollar exchange rate was trading at 1,476.6 won, up 10.5 won from the previous closing price (weekly close basis). During the overnight session the previous day, the exchange rate briefly broke through the 1,500 won level, opening at 1,479.0 won on publication day-up 12.9 won-and quickly approaching 1,480 won. However, after a verbal intervention from the Bank of Korea, it fell to 1,471.0 won.

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