Won-Dollar Exchange Rate, Increased Volatility in Q3... Expected to Fall to 1090 Won by Year-End

[Asia Economy Reporter Song Hwajeong] As the possibility of an early interest rate hike in the United States emerges, the KRW-USD exchange rate has risen, surpassing 1,130 won. Due to discussions on tapering (asset purchase reduction) in the U.S., it is expected that volatility in the foreign exchange market will increase in the third quarter, then decline and stabilize by the end of the year.

According to KB Securities on the 19th, as volatility in the global foreign exchange market expands in the third quarter, the KRW-USD exchange rate is expected to temporarily rise to around 1,145 won, the highest point of the year. The increase in foreign exchange market volatility is due to the possibility of an early interest rate hike in the U.S. KB Securities anticipates that discussions on tapering have already begun within the U.S. Federal Reserve (Fed), and that the July Federal Open Market Committee (FOMC) officially initiated tapering discussions, with a concrete tapering plan expected to be announced at the September FOMC.

After the tapering hurdle, the exchange rate is expected to decline and stabilize, falling to 1,090 won by the end of the year. Kim Hyojin, a researcher at KB Securities, explained, "Vaccination rates are expanding in countries outside the U.S. and Europe, and the European Recovery Fund is expected to begin injecting funds into the European economy in mid-third quarter or early fourth quarter, starting to reduce the growth gap between the U.S. and non-U.S. regions," adding, "Although South Korea's export growth rate will slow in the second half, it will maintain a relatively robust trend."

The narrowing gap in vaccination rates among countries is expanding the possibility of economic recovery in emerging markets. First, the disparity in vaccination rates among countries is rapidly decreasing. Researcher Kim said, "Except for Vietnam, Taiwan, and India, many countries have vaccination rates exceeding 20%," and added, "The acceleration of vaccinations will lead to economic recovery in emerging markets that were relatively behind, which will be a background for the strengthening of emerging market currencies." The Brazilian real remains depreciated by more than 20% compared to pre-COVID-19 levels. Based on accelerated vaccinations and expanded commodity exports, the currencies of emerging markets such as Brazil are highly likely to shift to a strong trend.

Expectations for European economic recovery are expected to lead to a gradual weakening of the dollar. Most European countries have vaccination rates exceeding 40%. Since there is a lot of intra-regional movement and trade in Europe, if vaccination speeds differ by country, the effect of economic recovery will inevitably be diminished. Researcher Kim said, "Intra-European movement will gradually normalize, leading to economic recovery within the European region," and added, "Along with the injection of the Recovery Fund, the European Union (EU) economic growth rate in 2022 is expected to be 4.2%, higher than the U.S. at 3.9%."

Externally, the gradual weakening of the dollar and export growth are expected to lead to a further decline in the KRW-USD exchange rate by the end of the year. South Korea's export growth rate in the second half is expected to slow due to base effects and the possibility of weakening U.S. goods demand, but it is anticipated to maintain a relatively robust trend compared to other countries. South Korea's export growth rate in May recorded 46%, exceeding the base effect. Researcher Kim analyzed, "This trend contrasts with Taiwan, where export growth slightly slowed, and China, where month-on-month exports slightly decreased," adding, "The won, based on the real effective exchange rate, is at the 10-year long-term average level, supporting export recovery."