The Bank of Korea woke up and smelled the coffee Thursday, signaling an abrupt change in its stance after the U.S. Federal Reserves upped rates and the won tanked.
Governor Rhee Chang-yong suggested the plan in place — of increasing the base rate by a quarter point at a time — may not be enough to hold the line as the Fed increases rates at a much faster pace.
“The preconditions to raising interest rates 0.25 percentage points each time through the end of the year have changed,” he said Thursday.
On Wednesday in the United States, the Federal Reserve increased the fed-funds rate by 75 basis points, and stocks in New York and currencies dropped immediately on the news, adding to concerns that financial markets globally will remain highly volatile in the face of higher borrowing costs.
With the third straight three-quarter point rise, the U.S. benchmark interest rate is now between 3.00 and 3.25 percent.
Rhee said the preconditions for the previous forward guidance was that base borrowing rates in the U.S. would be 4 percent by the end of the year.
“We expected the U.S. Federal Reserve’s final interest rate would stabilize at 4 percent,” Rhee said. “But overnight, the biggest change is that the market now expects interest rates to be more than 4 percent.”
Jerome Powell, the Fed’s chairman, on Wednesday signaled additional increases.
The Fed will have two more opportunities to raise rates by the end of the year. At the current pace, rates could be taken 1.25 percentage points higher. This could widen the interest rate difference between Korea and the United States from current 0.75 percentage points to as much as 1.5 percentage points.
“We have got to get inflation behind us,” Powell said. “I wish there were a painless way to do that. There isn’t.”
Higher interest rates in the United States have put pressure on the won, which is trading at decade-plus lows.
They have also put the Bank of Korea in a tough position, as higher domestic rates are needed to help stabilize the currency despite the risks of rate increases on the highly-indebted and vulnerable Korean economy.
Finance Minister Choo Kyung-ho tried to reassure the market before it opened on Thursday despite having few levers at his disposal.
“The current economic team is closely reviewing the impact on Korea’s financial and foreign exchange markets and on the real economy,” Choo said during a meeting with the heads of the Bank of Korea, the Financial Services Commission and the Financial Supervisory Service in Seoul.
“For the time being, the high-level of uncertainties in the world will continue,” Choo said. “As such, the current situation in our own country and moves in major markets have to be considered comprehensively and evaluated objectively and precisely.”
In the first minutes of trading on Thursday in Seoul, the won traded above 1,400 to the dollar for the first time since 2009 and stocks were down more than 1 percent.
The Kospi closed at 2,332.31, down 0.63 percent, while the won was up 15.5 to the dollar from the previous day to end at 1,409.7.
The market expects the strengthening of the dollar to continue throughout the remainder of the year.
“Earlier there were expectations that the U.S. Fed will pivot based on inflation peaking out,” said Kim Seung-hyuk, an NH Futures analyst. “Powell at Jackson Hole dashed those expectations, and inflation control has become clear as the Fed’s top priority.”
There were expectations of a currency swap discussion between President Yoon Suk-yeol and President Joe Biden during their meeting in New York Wednesday.
Choi Sang-mok, Yoon’s chief economic advisor told reporters in New York on Thursday that the presidents agreed on activating liquidity facilities if needed to stabilize the financial markets.
“There are many devices in liquidity facilities,” Choi said. “A currency swap is one of them.”
A $60 billion currency contract between the two countries expired at the end of last year and has yet to be renewed.
BY LEE HO-JEONG [firstname.lastname@example.org]