The U.S. Federal Reserve's decision to raise interest rates and keep the door open for further increases has introduced a new variable that may hinder the recent strength of the Korean won. The won-dollar exchange rate, which had fallen nearly 9% over the past six months to around 1,330 won, is now expected to rise again due to the Fed's tightening measures and the strengthening of the dollar.
On September 17, the exchange rate for the won against the U.S. dollar was 1,382.2 won at 3:30 PM in the Seoul foreign exchange market, an increase of 13.6 won from the previous session. This marks the first time the rate has surpassed the 1,380 won level since August 28. Analysts attribute this rise to heightened risk-averse sentiment following the Fed's interest rate hike and hawkish monetary policy stance.
During the Federal Open Market Committee (FOMC) meeting held on September 15-16, the Fed raised its target policy rate range by 25 basis points to 3.75% to 4.00%. This is the first increase since July 2023, marking a gap of over three years.
Fed Chair Kevin Warsh emphasized the commitment to price stability during a press conference following the FOMC meeting, while analysts suggest that inflation in the U.S. may not ease easily. Kim Sung-soo, a researcher at Hanwha Investment & Securities, noted, "Strong consumer spending suggests that service prices are unlikely to decline significantly, which could support the possibility of another Fed rate hike in December."
The Fed's tightening is also expected to impact domestic monetary policy in South Korea. The Bank of Korea (BOK) is considering the possibility of additional interest rate hikes this year, taking into account inflation and financial stability.
After raising the base rate from 2.50% to 2.75% in July, the BOK increased it again to 3.00% in August, marking two consecutive months of rate hikes. This proactive measure was aimed at addressing inflation and financial stability risks. In its August monetary policy statement, the BOK indicated that inflation is expected to exceed target levels for an extended period, necessitating preemptive action to prevent further price increases.
Moreover, persistent inflationary pressures and robust growth driven by exports and investments are cited as factors that could lead to further rate hikes. In its September monetary credit policy report released on the 10th, the BOK projected that inflation would remain above target levels for a considerable time and stated it would assess future inflation, economic trends, and financial stability to determine the timing and pace of any additional rate increases.
Given the two consecutive rate hikes, the BOK is likely to approach any further increases cautiously to evaluate the effects of its policies. The median forecast from the BOK's monetary policy committee members for the base rate six months ahead is 3.25%, which is 25 basis points higher than the current rate.
However, a challenge remains: even if the BOK raises rates, the potential for further increases by the Fed could limit the narrowing of the interest rate gap between South Korea and the U.S. Following the Fed's recent hike, the interest rate differential has widened from 0.75 percentage points to 1.00 percentage points. Even if the BOK raises rates once more this year, if the Fed also increases rates, the interest gap may not significantly narrow, which could limit the impact of domestic rate hikes on the strength of the won.
Additionally, the domestic supply conditions that previously supported the won's strength are weakening. In July and August, a surge in dollar supply from exporters helped strengthen the won, but this supply advantage appears to be diminishing. The won-dollar exchange rate, which rose to nearly 1,560 won in early June, fell to around 1,330 won earlier this month but has recently started to rebound.
Nonetheless, some analysts predict that if the strong dollar pressure eases, downward pressure on the exchange rate could increase again. Moon Da-woon, a researcher at Korea Investment & Securities, stated, "Considering the current external situation, there is likely to be upward pressure on the exchange rate until early November, before the U.S. midterm elections. The factors currently pushing the exchange rate higher are external strong dollar pressures, and once these pressures ease, domestic conditions may lead to renewed downward pressure on the exchange rate."
* This article has been translated by AI.
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