South Korea’s central bank got ahead of the tightening curve last year but now faces pressure to move faster and farther as the weakening won fuels inflation and the U.S. Federal Reserve takes a big-step approach to raise rates.
The Bank of Korea, the first major Asian central bank to shift away from crisis-era settings last August, must address a narrowing policy-rate gap with the United States. If domestic rates trend lower than U.S. rates, capital outflows could pile more pressure on the currency.
Investment banks and economists are starting to change their assessment of how fast the BOK will raise rates, with some predicting the key rate will rise as high as 2.50% by the end of the year, from 1.50% currently.
Governor Rhee Chang-Yong, perceived to be less hawkish than his predecessor, will be chairing his first policy meeting this month when factors such as the Russia-Ukraine war make it harder to predict when inflation will eventually cool.
“Inflation repeatedly topped expectations and this means the South Korean policy rate fell in real terms despite recent hikes,” JPMorgan Chase Bank economist Seok Gil Park said. The bank raised its rate projection to 2.50% by year-end from 2.00% previously.
The Won has fallen nearly 7% so far this year to around 1,273 per dollar after last year’s near 9% loss. It looks set to breach the psychologically-important 1,300 won barrier for the first time since the 2008/09 global financial crisis.
The won has weakened on foreign sales of domestic shares and a worsening trade balance, among other factors, which bodes ill for inflation. South Korea is heavily dependent on imports of energy, food, and industrial components.
Both the BOK and the Fed will meet five times each for the rest of this year, but the latter is widely expected to raise its policy rate by bigger margins than the former.
The won’s slide had often raised concerns among investors over the health of Asia’s fourth-largest economy, which barely avoided bankruptcy in the late 1990s and suffered an exodus of capital in 2008-2009.
Minutes of the BOK’s April 14 meeting showed a small majority of board members calling for vigilance over the won’s decline and the risk of foreign capital outflows.
“Can the rate gap alone stoke a capital outflow? Yes, and that’s why we need to be very careful about the (negative) rate gap taking place,” said Kim, who was governor from 2010-to 2014.
The mid-point of the U.S. target range is seen reaching 2.125% by year-end, according to a Reuters survey, while the BOK’s base rate is tipped to reach 2.00%.
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