The rate gap could narrow further if the BOK continues tightening while the Federal Reserve holds rates steady, although its governor Shin Hyun-song said future rate decisions would depend on trends in growth, inflation, foreign exchange rates, housing markets, and household debt.
The seven-member board unanimously backed the rate hike, while the Fed kept its rate unchanged at 3.50 percent to 3.75 percent. The move narrowed the two countries' interest rate gap to 75 to 100 basis points from 100 to 125 basis points.
The maximum gap, measured against the upper end of the U.S. range, is now at its smallest since February 2023.
One additional quarter-point rate hike by the BOK, while the Fed remains on hold, would further narrow the gap to between 50 and 75 basis points.
Softer-than-expected U.S. consumer and producer inflation data reduced the futures-implied probability of a July Fed increase to 10.2 percent.
"We believe further rate hikes are still needed," Shin said, adding that future decisions would be based on inflation, economic growth, and financial stability.
The remark indicates that the BOK has not predetermined its future policy path and will continue to assess economic conditions before making further decisions.
Shin did not give a direct view on the 3.50 percent terminal-rate scenario. He instead pointed to second-quarter GDP and GDI data due next week, July inflation figures due Aug. 4 and developments in the exchange rate, housing market and household lending as key inputs for future decisions.
If the Fed remains on hold, a BOK rate of 3.00 percent would reduce the maximum gap, measured against the upper end of the U.S. range, to 75 basis points, while a rate of 3.25 percent would narrow it to 50 basis points. The differential would fall to 25 basis points at 3.50 percent, although these are mechanical scenarios rather than BOK forecasts.
The relationship is not mechanical, however, as the won is also shaped by the global dollar cycle, foreign equity transactions, exports, oil prices and geopolitical risks.
"The exchange rate remains at a high level and has fluctuated widely," Shin said, adding that the central bank needed to remain attentive to the related risks.
He said the BOK was examining how the narrowing gap and round-the-clock onshore won trading affect offshore non-deliverable forward activity, which has yet to contract noticeably, and plans to publish separate research on the issue.
The won weakened to the mid-1,500 range against the dollar on foreign stock outflows and broad dollar strength before recovering to the upper 1,400 range as foreign exchange supply-demand conditions improved.
The largest external variable remains the Fed's actual policy path and its effect on the global dollar, with renewed U.S. inflation or oil-price pressure capable of reviving expectations for further tightening.
Foreign trading in South Korean equities also directly affects demand for the won, and the BOK cited foreign stock outflows as one of the main factors behind the currency's recent weakness.
In the opposite direction, strong semiconductor-led exports and a large current-account surplus could increase foreign-currency supply and ease some pressure on the won.
May's balance-of-payments data, however, showed how that support could be offset by financial outflows. Korea posted a current-account surplus of US$38.61 billion, while nonresidents' portfolio investment in Korean securities fell by $24.65 billion, including a $31.05 billion decline in equity investment, partly offset by a $6.4 billion increase in debt investment.
South Korean residents also increased their overseas portfolio investment by $6.24 billion. The current and financial accounts do not translate one-for-one into exchange-rate movements, but the figures illustrate how foreign equity selling and residents’ overseas investment can limit the immediate support for the won even when export-related foreign-currency inflows are exceptionally strong.
Oil prices and developments in the Middle East are another major variable through their effects on South Korea's import bill and global demand for safe-haven assets.
Higher crude prices and a weaker won could lift import prices, strengthening the case for further BOK tightening and indirectly contributing to an additional narrowing of the rate gap.
Shin said the currency had stabilized somewhat from several weeks earlier but remained elevated, while import prices were still 20 percent higher than a year earlier.
Domestically, semiconductor prices are likely to play a central role in determining the timing and pace of further BOK increases.
First-quarter gross domestic product rose 3.8 percent from a year earlier, while gross domestic income surged 13.2 percent, largely reflecting an improvement in South Korea's terms of trade driven by higher chip prices.
Headline inflation stood at 3.2 percent in June and core inflation at 2.5 percent, while rising home prices in the Seoul metropolitan area and monthly household-loan growth of 8 trillion won to 9 trillion won provide additional arguments for further tightening.
Policymakers will review second-quarter GDP and GDI data due next week, followed by July core and living-cost inflation figures on Aug. 4, before deciding the timing and pace of their next moves.
The bilateral gap could narrow rapidly if the Fed stays on hold while the BOK continues raising rates, but that would remove only one disadvantage facing won-denominated assets rather than guarantee foreign inflows or sustained currency appreciation.
Financial markets showed a limited response to the decision. The won traded slightly firmer at 1,483 per dollar at 2 p.m., while the three-year Korean Treasury bond yield fell 0.4 basis point to 3.862 percent and the 10-year yield edged up 0.2 basis point to 4.329 percent at the morning close, suggesting that the quarter-point increase had been largely priced in.
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