Choonsik Yoo

SEOUL (Reuters) – South Korea’s central bank jumped ahead in the tightening curve last ye, but is now facing pressure to move more quickly and further as inflation increases and weakening forces the U.S. Federal Reserve to raise rates.

The Bank of Korea is the Asian’s first central bank to abandon crisis-era policies last August. It must close the gap between its policy rates and the United States. The currency could be under more pressure if the domestic rate trend is lower than U.S rates.

Economists and investment banks are changing their opinions on the rate at which the BOK raises rates. Some predict that the key rate could rise to 2.50% in the next year from 1.50%.

The Governor Rhee Changyong is perceived as less hawkish that his predecessor. This month’s first policy meeting will be presided over by the governor. It will take more effort to forecast when inflation will cool due to factors like the Russia-Ukraine conflict.

Seok Gil Park, JPMorgan Chase Bank (NYSE:) Bank economist said that “inflation consistently exceeded expectations” and South Korea’s policy rate fell in real terms despite recent rises. It raised its year-end rate projections to 2.50% from 2.00%.

After a nearly 9% drop last year, the won is down almost 7% to 1,273 dollars. It looks set to breach the psychologically-important 1,300 won barrier for the first time since the 2008/09 global financial crisis.

The won is expected to fall due to foreign sales of local shares, and worsening trade balance. South Korea relies heavily on imports for energy, food, and other industrial components.

According to data from official sources, import prices in won terms rose by at least 30% annually over the last six months. This has helped drive up consumer inflation, which reached a record 10 year high in April, from below 2.5% just six months ago.

Policymakers at central banks must worry about capital flight as well as inflation.

U.S., South Korean policy rates https://fingfx.thomsonreuters.com/gfx/mkt/myvmnylxbpr/won1.png

NEGATIVE RATE GAP CONCERNS

From 112.5 points in January, South Korea’s premium for the policy rate over the U.S. Fed funds rate midpoint has fallen to 62.5 basispoints now.

According to Reuters, the midpoint of the U.S. target rate range will reach 2.125% in the year-end. The base rate for the BOK is expected to be 2.00%.

Chung Sungtai (KS:) Securities senior economist, said that policymakers were closely monitoring the situation in terms of financial stability and capital flows. He pointed out that the won is falling despite numerous calls for intervention.

For the rest of 2018, both the Fed and BOK will meet five times, with the Fed expected to raise its rate faster than the Fed.

Investors were often concerned about the future of Asia’s fourth largest economy. It was unable to avoid bankruptcy in the 1990s, and experienced a capital flight in 2008-2009.

The minutes of April 14, 2014 meeting of the BOK showed that a smaller majority of members called for increased vigilance regarding the will’s decline as well as the possibility of capital outflows.

South Korea’s won weakening https://fingfx.thomsonreuters.com/gfx/mkt/movanoaddpa/won2.png

South Korea says its economic fundamentals have improved in recent years. But, Kim Choongsoo (former governor of Bank of Korea) told Reuters that the Bank of Korea’s capital flows are still a concern.

Foreign net sales occurred on South Korea’s main stock exchanges in every quarter except two, and totaled 63.05 trillion won (or $49.5 billion) during each quarter. This quarter, foreign investors have also sold.

Can the rate gap be enough to cause capital outflows? Kim was the governor between 2010 and 2014.

($1 = 1,274.0100 won)