BOK's back-to-back rate cuts to accelerate weakening of won, experts say

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BOK's back-to-back rate cuts to accelerate weakening of won, experts say

Published: 30 Nov. 2024, 07:00 Updated: 30 Nov. 2024, 15:35

SHIN HA-NEE
[email protected]

Audio report: written by reporters, read by AI

An employee arranges stacks of dollar bills at Hana Bank's Counterfeit Notes Response Center in Jung District, central Seoul, July 3.[NEWS1]

The Bank of Korea's (BOK) surprise back-to-back interest rate reductions and signals of further cuts will likely accelerate the country's capital outflow and the won's depreciation against the dollar, a development that has already taken shape following Donald Trump's election victory.

The 1,400 won per dollar mark, which has long been a significant threshold, is becoming less of an outlier as the exchange rate continues to hover in the 1,390 to 1,410 range — a trend that is expected to persist, especially given that policymakers appear to be accepting it as the new norm.

“The BOK does not set a specific target range for foreign exchange rates, and I believe that the economic structure has changed significantly to consider a certain range as a ‘crisis’ level,” said BOK Gov. Rhee Chang-yong during a news conference following Thursday's rate-setting meeting, addressing whether the central bank considers the current won-dollar exchange rate acceptable.

Rhee stressed that the pace of exchange rate fluctuations, or volatility, is a higher priority than the rate itself.

“The pace of the won’s depreciation has not been particularly worse than other currencies,” said the governor, adding that, “We have sufficient will and tools to adjust the pace [of appreciation] based on the foreign exchange situation.”

The decision, according to Woori Bank economist Min Gyeong-won’s report released Friday, “has likely sent a signal to foreign exchange market participants that the authorities are willing to accept a somewhat high level of exchange rates.”

A won-dollar exchange rate of 1,400 has been widely considered a theoretical threshold that could warrant government intervention. Before last year, the rate had surpassed that mark only during three major financial crises: the 1997 Asian financial crisis, the 2008 global financial crisis and 2022 post-pandemic monetary tightening.

But it is no longer a rarity, as the won-dollar exchange rate soared above the 1,400 threshold midtrading on Nov. 6, following the U.S. presidential election, and closed above the mark for four sessions in a row from Nov. 13 to 18. It has hovered between 1,390 and 1,410 won since then.

A high won-dollar rate may stimulate inflation by pushing up import prices and further accelerating the outflow of foreign capital in the short term. The BOK, however, expects consumer prices to remain stable through next year due to lower global fuel prices and relatively weak demand, and is thus prioritizing growth amid a moderation in exports.

As such, the central bank lowered its 2025 inflation projection to 1.9 percent from its previous forecast of 2.1 percent.

Bank of Korea Gov. Rhee Chang-yong bangs the gavel at the central bank in central Seoul on Thursday. [JOINT PRESS CORPS]

“The surprise rate cut and tone during its news conference on Thursday suggest that the central bank’s policy priorities have changed to growth, foreign exchange, household debt and inflation, in that order, from household debt, foreign exchange, growth, and inflation previously,” said Yoon Jee-ho, a senior economist of Korea at BNP Paribas.

The persistent strengthening of the dollar has already begun to impact the patterns of Korean consumers, as overseas direct purchase volume from the United States has been shrinking over the past few years.

The amount of direct purchases from the United States, which stood at 464.1 billion won ($332.6 million) in the third quarter of 2022, declined to 451.2 billion won last year and to 406.1 billion won this year, according to Statistics Korea. The total volume of overseas direct purchases increased from 1.44 trillion won to 1.91 trillion won during the same period, with China driving the growth.

Founded on a changed macro situation with slow economy and low inflation, the surprise rate cut is “a pre-emptive measure to address the potentially worse economic environment that the Korean economy is expected to face under the second Trump term,” said Kim Jin-seong, an economist at Heungkuk Securities.

However, Kim noted that “a continued increase in the won-dollar rate will likely weigh on aggressive rate-cut decisions,” suggesting that “flexible action is needed regarding potential inflationary pressure driven by Trump’s policies and slower U.S. rate cuts.”

BY SHIN HA-NEE [[email protected]]