As won nears crisis level of 1,600 to the dollar, jumbo rate hike by BOK looms

Korea is posting the kind of economic numbers that would typically support a stronger currency, with exports at record highs and stocks riding a powerful rally. Yet the won remains stubbornly weak, trading above 1,500 per dollar for the longest stretch since the Asian financial crisis as the strength of the U.S. currency continues to outweigh positive domestic fundamentals.

The won stabilized at 1,512.1 on Tuesday after financial authorities vowed a forceful response to excessive market volatility, while the National Pension Service activated its currency-hedging program. Still, the won remains near historic lows, fueling inflation concerns and complicating the Bank of Korea's (BOK) policy calculus, including the possibility of a 50-basis-point rate increase in the July board meeting.

Financial authorities have blamed speculative activity in the offshore nondeliverable forward (NDF) market as a key driver of the won's recent weakness, discussing possible measures to channel NDF demand into the onshore deliverable foreign-exchange market to curb speculative trading.

But economists argue that the pressures are more structural. They cite broad dollar strength fueled by persistent tensions in the Middle East, rising inflationary pressures that could keep the U.S. Federal Reserve on a hawkish path and foreign investors' profit-taking in Korean equities.

Analysts warn that the won could face further depreciation, with some suggesting the possibility of the currency approaching 1,600 per dollar. “Based on these strong economic fundamentals, the won's recent weakness appears to be an overshoot, driven by a convergence of domestic and external headwinds,” said Moon Da-woon, an analyst at Korea Investment & Securities.

Whether the won extends its slide will depend largely on upcoming economic data and geopolitical developments. "If the Middle East conflict drags on and won-negative factors continue to mount — including stronger-than-expected U.S. May inflation data and a hawkish shift at next week's Federal Open Market Committee (FOMC) meeting — the dollar-won rate could climb as high as 1,600," she added.

A potential jumbo hike

As the won remains at historically weak levels, some market participants say the BOK could be forced to take more aggressive steps to contain inflationary pressures, including the possibility of a 50-basis-point rate increase in the next monetary policy board meeting scheduled in July.

A weaker won typically leads to higher import costs, stoking inflation concerns that have already moved to the forefront following the outbreak of the Iran war, which pushed global oil prices higher.

The discussion on a half-percentage-point increase has gained traction as some global peers moved pre-emptively. The Bank Indonesia, for instance, raised its benchmark rate by 25 basis points on Tuesday to 5.5 percent in a surprise off-cycle move after it raised 50 basis points in May in a bid to defend the rupiah and inflation risks.

“If the won approaches the 1,600 level, we should keep open the possibility of a 50-basis-point hike to prevent excessive one-sided positioning and limit the pass-through impact on inflation,” said Cho Ji-wook, an analyst at Korea Investment & Securities.

According to central bank estimates, a 10 percent rise in the dollar-won exchange rate lifts consumer prices by about 0.2 to 0.3 percent over a one-year horizon.

“If policy measures led by the foreign exchange authorities fail to have a meaningful effect, we cannot rule out pre-emptive action, including a ‘big step’ rate hike,” Cho added.

Some economists say the situation is urgent enough to warrant an emergency monetary policy board meeting at the BOK.

Citi economist Kim Jin-wook on Monday pointed to the possibility of an unexpected 25-basis-point rate hike via an off-cycle meeting in June while forecasting the bank to raise rates in July and October and again in January and April of next year, reaching a terminal rate of 3.5 percent.

Though the BOK doesn’t have a scheduled board meeting in June, an unscheduled meeting can be convened in response to major domestic or global financial shocks or heightened foreign exchange market instability. During the early phase of the pandemic in March 2020, the BOK held an emergency meeting and cut its benchmark rate by 50 basis points to cushion the economic downturn.

Structural changes weigh on the won

Beyond near-term policy expectations, some analysts say the won’s weakness reflects deeper structural shifts that may be difficult to change in the short term, citing a structural shift in global supply chains under U.S. onshoring policies, which seek to redirect production toward North America and certain partner countries.

“The shift in the supply chain network has boosted corporate investment into the United States and encouraged Korean investors’ overseas equity purchases,” said Park Seok-hyun, an analyst at Woori Bank.

“U.S. onshoring policies are being pursued amid power competition with China, making a shift in that policy stance highly unlikely. In this environment, the dollar is structurally biased toward strength, which in turn is contributing to a gradual upward drift in the dollar-won exchange rate,” Park added.

Korea has committed a total of $350 billion in investment to the United States, including a $150 billion Korea-U.S. shipbuilding cooperation initiative. As for retail investors, they net purchased $8.78 billion of U.S. stocks this year, according to data from the Korea Securities Depository.

Last week’s upside surprise in nonfarm payrolls in the United States has further added to a cluster of overlapping pressures, as it overturned the Fed's justification for rate cuts. Higher U.S. rates typically lift dollar yields, drawing global capital toward dollar assets and away from risk-sensitive currencies such as the won. As expectations of further rate hikes gained traction, the dollar index has recently climbed back above the 100 mark for the first time in two months, though the figure slid below the market Tuesday.

Expectations of the won’s further weakness have also kept potential dollar sellers on the sidelines, skewing flows heavily toward dollar buying and fueling bouts of panic-driven demand in the foreign exchange market.

Corporate dollar deposits across the five major banks — KB Kookmin, Shinhan, Hana, Woori and NH Nonghyup — stood at $53.39 billion as of June 4, up $3.461 billion from the end of the previous month, according to a report from Sedaily.

Analysts say the near-term trajectory of the won will hinge on whether inflationary pressures show signs of peaking or continuing to build.

“For the won to stabilize, oil prices would need to ease after the war for this week’s U.S. inflation data [on June 10] to be seen as a peak, supporting expectations that price pressures have topped out,” Moon explained. “But if the conflict continues and oil prices fail to decline, the inflation peak could be pushed further out into June, which could increase expectations of rate hikes at the FOMC.”

BY JIN MIN-JI [[email protected]]