Coping with the Jackson Hole repercussions

The unequivocal hawkish tone in the address by U.S. Federal Reserve Chairman Jerome Powell at the central bank’s annual economic symposium at Jackson Hole, Wyoming, on Friday has rattled capital markets in Korea. Powell made it clear that increases in the benchmark rates would have to continue until inflation comes down to the 2 percent goal. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said. He added that a failure to restore price stability could mean “far greater pain.”

The Dow Jones and Nasdaq index crashed more than 3 percent. The weekend bombshell spilled over to Korea’s stock and foreign exchange markets. The Korean won sank 19.1 won from previous closing to 1,350.40 won against the U.S. dollar shortly after opening on Monday. The Korean won has not devalued at such a level since the 2008 global financial crisis and the 1997 Asian currency crisis. The Kospi lost more than 2 percent and Kosdaq nearly 3 percent.

The tightening tantrums will likely weigh over the Korean markets for some time. In an interview on the sidelines of the Jackson Hole symposium, Bank of Korea Gov. Rhee Chang-yong said that the Korean central bank would prioritize restoring price stability as the Fed does when inflation flies above 5 percent. Rate increases beyond the usual 25 basis points could be possible if prices are not tamed. The BOK delivered an unprecedented fourth back-to-back rate hike last week, following the first-ever hike in 50 basis points in July.

Korea’s base rate at 2.50 percent has come on par with the U.S. Fed funds rate target of 2.25-2.50 percent. But if the Fed keeps taking big steps after delivering hikes in 75 basis points in July and June and 50 basis points in May, the difference in the rates of the two countries would yawn. The market expects the Fed to deliver another increase by 75 basis points after a Sept. 21 meeting. Rhee so far has maintained the rate increases in Korea would be kept at the incremental level of 25 basis points to bring the base rate at 3 percent through the remaining two meetings.

Although slightly eased from June levels, U.S. inflation rose 8.5 percent in July. Powell made it clear that the rate increases won’t stop until inflation falls by 3 percentage points. Korea’s economy faces a greater challenge. Due to sharp weakening of the Korean won on top of rises in oil and commodity prices, the deficit in trade balance has already topped $10 billion in the first half. The government must raise vigilance to prevent the instability building up to a crisis as the volatile conditions are expected to continue throughout next year until prices come down.