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Won's tumble strengthens case for sharp rate hikes, darkens outlooks for economy

By Koh Byung-joon

SEOUL, Sept. 22 (Yonhap News)

A recent accelerating slide in the local currency against the U.S. dollar is feared to aggravate uncertainty over the South Korean economy already struggling in the face of galloping inflation, high borrowing costs and worries over slowing growth, observers said Thursday.

The won's sharp depreciation will likely exert upward inflation pressure and increase the cost of borrowing that experts worry could undercut the growth momentum of Asia's fourth largest economy by dampening consumption and corporate investment.

The Korean currency closed at 1,409.70 won per dollar on Thursday, down 15.50 won from the previous session. It had fallen through the 1,400 mark for the first time since March 20, 2009, when the local currency ended at 1,412.50 won against the greenback.

The won's tumble came as the dollar rallied following the U.S. Federal Reserve's overnight decision to raise its target interest rate by 75 basis points for a third straight time.

The U.S. central bank on Wednesday (U.S. time) hiked the federal funds rate to a range of 3-3.25 percent, the highest since 2008, and hinted at further large hikes. Fed Chair Jerome Powell also reaffirmed his resolution to tame inflation, saying he would "keep at it until the job is done."

The sharp fall in the won's value is raising yet another cause for concern for South Korea's economy, which has been faced with high inflation driven up by rising energy and commodity prices amid the prolonged war in Ukraine.

The country's consumer prices, a key gauge of inflation, jumped 5.7 percent in August from a year earlier, which is still high, though it slowed from the previous month's 6.3 percent on-year rise. A weak currency would heighten inflation pressure by making imports more expensive.

Worries over fast price growth would augment the central Bank of Korea's (BOK) case for sharp rate hikes down the road, which would increase the cost of borrowing for households and businesses and eventually dampen consumption and investment, which have been showing signs of a rebound from the fallout of the pandemic.

The BOK has raised its policy rate seven times by a combined 2 percentage points since August last year as part of efforts to fight inflation. It raised the rate by an unprecedented "big step" of 0.5 percentage point in July, followed by a 0.25 percentage point increase last month.

BOK Chair Rhee Chang-yong said in July he is not likely to push for such a sharp rate hike and vowed to seek "piecemeal" increases unless there is a big shock, apparently referring to quarter percentage-point raises.

The top central banker, however, appears to have changed his stance, apparently affected by the won's sharp slide.

"The preconditions for 0.25 percentage-point hikes have changed much," Rhee told reporters Thursday. "It is the BOK's big responsibility to gauge the impact of the currency exchange rate on prices and what policy it has to take to deal with it."

Market watchers say the BOK could raise the interest rate twice in the remaining two meeting until the end of this year.

Some even speculate the central bank will hike the rate by 50 basis points at a meeting slated for Oct. 14 due to worries over possible capital outflows prompted by a rate reversal that could prompt investors to leave for the U.S. in pursuit of higher returns.

"We believe that the case for the BOK's bigger step has risen this week, as uncertainty about the U.S. monetary policy path decreased in a hawkish direction," Park Seok-gil, an analyst at JPMorgan Chase, said in an emailed release.

"We now expect that the BOK will hike the policy rate by 50 basis points at its October meeting, preventing an 'excessively wide' policy interest rate differential with the U.S.," he added.

Further rate hikes are feared to deepen worries that they could slow down the economic growth too much at a time when it has already been faced with heightened uncertainty amid worries that monetary tightening in major markets would result in a fall in demand in such countries as the U.S. and China.

A weak currency usually makes a country's exports cheaper, making its price competitiveness sharper. But the won's recent devaluation came along with sharp declines in other major currencies of its competitors as the dollar maintained its upward move.

The gloomy outlooks have materialized in recent trade data.

Last month, South Korea's exports shrank 6.6 percent on-year, with overseas shipments of semiconductors, one of its mainstay export items, falling for the first time in more than two years.

With import bills of energy on the rise, the country posted about US$9.5 billion in trade deficit last month, the largest shortfalls since relevant data began to be compiled.

Adding to the woes, the BOK earlier said there is a possibility that the country's current account balance would also turn into a deficit in August, raising concerns over rare "twin shortfalls" for the export-driven economy.

The shortfalls mean fewer dollars in the market and more downward pressure on the won's value per dollar.

The government has tried to assuage concerns, saying the country's external soundness has not been hurt significantly but vowed to closely monitor the supply and demand of dollars in the market.

"By mobilizing all possible means, the government will sternly deal with (the herd behavior) in a decisive and swift manner, when needed," Finance Minister Choo Kyung-ho told reporters after a meeting with the chief of the central bank and top financial regulators Thursday.

Market watchers, however, said the government has to brace for more devaluation of the won against the dollar, as the Fed is expected to continue monetary tightening, and cause investors to become averse to risks and pull back their money from emerging markets.

"There is a high possibility that the Fed will maintain its hawkish stance for a while," an analyst at Hana Bank said. "We will have to leave the possibility open that the won-dollar exchange rate could rise to as high as the 1,430-1,450 range."

Reference: Link

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