[INTERVIEW] BOK tone shifts as inflation eclipsed by won weakness

Arup Ghosh, co-head, Asia Rates Research at Standard Chartered Bank, speaks during an interview with the Korea JoongAng Daily at the bank's Seoul office on Jan. 18. [PARK SANG-MOON]

Falling expectations of an early rate cut by the U.S. Federal Reserve has led to a general weakening of the won, which has become a bigger concern for the Bank of Korea than inflation.

Korea's currency fell to a two-month low last week as disappointment set in over the pace, timing and magnitude of anticipated monetary policy weakening in the United States after Federal Reserve Gov. Christopher Waller signaled a cautious stance on rate cuts.

The upping of geopolitical tensions following the victory of a U.S.-friendly leader in Taiwan also contributed to the currency's decline.

It traded at 1,346.7 to the dollar on January 17, the first time since November that the won was at those levels.

The Bank of Korea's concern about won volatility is evident in its change of language, according to Arup Ghosh, co-head, Asia Rates Research at Standard Chartered Bank.

Bank of Korea Gov. Rhee Chang-yong "mentioned last year when the Korean won was appreciating in the second half that it can focus more on domestic conditions and it's less concerned about the interest-rate differential versus the United States," Ghosh said in an interview in central Seoul on Jan. 18.

"But subsequently, the language changed. So it's quite clear that the Korean won stability is a priority compared to domestic inflation."

Rhee noted the weak won as one of the factors that the board took into consideration in keeping the rate unchanged at 3.50 percent on Jan. 11.

"The recent weakness in the won is not very Korea specific, as we have seen other emerging market currencies come under pressure as well."

A lot of the emerging market central banks in the current cycle are not questioning inflation, but they are concerned about the currency because China's growth has "slowed down quite significantly."

"China is actually exporting deflation to the rest of the world as Asia is largely a trade dependent economy."

China reported a third straight month of consumer price declines.

The consumer price index (CPI), a main gauge of inflation, fell 0.3 percent on year last month.

The recent Taiwan presidential election and Donald Trump's lead in the polls for the November presidential election are renewing concerns on geopolitics in the Asia-Pacific region, raising volatility of high beta currencies like the won.

Trump instituted multiple sanctions on China during his presidency, which stoked fears of a trade war.

Korea's trade with China would remain weak amid geopolitical tension, but the U.S.-China friction will raise foreign institutional investor and foreign direct investment inflows into Korea, as funds get pulled out of China.

"That money is going elsewhere," Ghosh said, and Korea will be one of the beneficiaries as the Bank of Korea has "a lot of room" to cut rates, unlike China that does not have a lot of room to cut rates as it doesn't want indiscriminate credit expansion.

The People's Bank of China left its one-year medium-term lending facility loans to some financial institutions unchanged at 2.50 percent earlier this month from the previous operation.

Standard Chartered Bank expects the won to start to recover once the Fed starts monetary easing, with a forecast for the currency to trade between 1,250 to 1,275 to the dollar by the end of the year.

"The rate cuts would start sometime in the third or the fourth quarter, and the Fed is not going to cut twice or three times and stop," Ghosh added. "It will go through a rate cutting cycle," and that will result in further appreciation potential next year.

BY JIN MIN-JI [jin.minji@joongang.co.kr]