If the Exchange Rate Surpasses 1,600 Won, Inflation Could Surge… Will the Bank of Korea Raise the Rate by 0.5% at Once? [Weekend Money]

Authorities Put Out Immediate Fire with Intervention
South Korea in a Different League from Indonesia Amid Fiscal Deterioration

The possibility has been raised that the Bank of Korea may take a “big step” by raising the benchmark interest rate by 0.50 percentage points at the Monetary Policy Committee meeting next month. Analysts say a preemptive rate hike will be inevitable if the won-dollar exchange rate approaches the 1,600 won level, despite various foreign exchange market stabilization policies.

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According to Korea Investment & Securities on June 13, the won-dollar exchange rate recently rose to the 1,560 won range due to robust U.S. employment data. Afterwards, verbal intervention by the foreign exchange authorities and the National Pension Service’s resumption of forward dollar sales helped stabilize the rate, bringing it down to the 1,520 won range. Earlier in April, the National Pension Service raised its foreign investment currency hedging ratio from 10% to 15%.

Currently, there is speculation in the market that the Bank of Korea may also raise its benchmark interest rate by 0.50 percentage points, from 2.50% to 3.00% per year, following the precedent set by Bank Indonesia’s recent 50bp rate hike. However, the situation in Indonesia is entirely different. Indonesia received a “negative” outlook from international credit rating agencies Moody’s and Fitch due to worsening fiscal soundness, and its current account is expected to post a deficit.

In contrast, South Korea enjoys solid fiscal soundness and maintains a current account surplus, thanks to the boom in semiconductors and the artificial intelligence (AI) cycle. Therefore, the fundamental causes of currency weakness differ between the two countries. Furthermore, domestic foreign currency liquidity remains abundant, so rather than immediately taking a big step, approaches such as expanding foreign exchange swap volumes with the National Pension Service are expected to be prioritized.

However, if the exchange rate surpasses its previous peak and approaches the 1,600 won level, the situation is expected to change. This is because a sharp rise in the exchange rate has a significant ripple effect on prices. According to the Bank of Korea’s model analysis, a 10% increase in the won-dollar exchange rate results in a short-term effect of a 0.31 percentage point rise in consumer prices over the course of a year. Especially if the exchange rate remains elevated for more than three months, the long-term effect on consumer prices can amplify to 1.30 percentage points, which can have a serious impact on long-term inflation. If the average annual exchange rate rises to around 1,565 won this year, the inflationary burden will be impossible to ignore.

Choi Jiuk, a researcher at Korea Investment & Securities, said, “If policies led by the foreign exchange authorities do not prove to be effective, the possibility of a preemptive big step should be left open.”

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