Exchange Rate Hits Highest in Four Months... Lee Chang-yong Says "New Considerations for Interest Rate Decisions"

Exchange Rates and Interest Rates Emerge as Key Determinants
If Upward Trend Continues, Interest Rates Likely to Remain Steady Next Month

In the Bank of Korea's base interest rate decision in November, the exchange rate emerged as a major variable. For the time being, the exchange rate is expected to increase volatility as it awaits big events such as the U.S. presidential election on the 5th (local time) and the Federal Open Market Committee (FOMC) meetings on the 7th and 8th of next month. If the won-dollar exchange rate, which has risen to just below the 1400 won level, continues its upward trend, it will be difficult for the Bank of Korea's Monetary Policy Committee to decide on a rate cut next month.

[Image source=Yonhap News]

On the 28th, in the Seoul foreign exchange market, the won-dollar exchange rate was fluctuating near the 1390 won level as of 9:50 a.m. On that day, the won-dollar exchange rate opened at 1390.5 won, up 1.8 won from the previous trading day's closing price at 3:30 p.m. This is the highest level in over four months since June 27 (1394.4 won) based on the opening price.

On the 25th, the won-dollar exchange rate closed at 1388.7 won, up 8.5 won from the previous trading day (closing price at 3:30 p.m.), marking the highest closing price since July 3 (1390.6 won). The won-dollar exchange rate continued its upward trend in the early morning session on the 26th, reaching as high as 1392.2 won during the day.

The strong dollar trend is putting upward pressure on the exchange rate. Recent robust U.S. economic indicators have lowered expectations for further rate cuts by the Federal Reserve (Fed), while as the election approaches, the market has reflected the 'Trump trade,' betting on the possibility of former President Donald Trump's victory, sustaining the dollar's strength. Asian currencies such as the yen and yuan are also showing weakness.

The deterioration of Middle East tensions, such as Israel's airstrike on Iranian military targets on the 26th, is also adding pressure to the dollar's strength. If military tensions escalate in the Middle East, global risk aversion sentiment will strengthen, increasing preference for the dollar as a safe-haven asset.

The dollar index, which shows the value of the dollar against six major currencies, has risen from around 100 at the end of last month to about 104 currently. The dollar index breaking through the 104 level is the first time in about three months since early August.

The won-dollar exchange rate, which was 1319.60 won at the end of last month, has continued to rise, increasing by about 70 won throughout October.

Accordingly, the vigilance of foreign exchange authorities is increasing. When the won-dollar exchange rate touched 1400 won intraday in April, setting a yearly high, the authorities verbally intervened to prevent further rises in the exchange rate.

Choi Sang-mok, Deputy Prime Minister and Minister of Strategy and Finance, said in an interview with Bloomberg on the 24th (local time), "We are aware of market concerns that the won is moving relatively quickly compared to other currencies," adding, "We will remain vigilant about exchange rate volatility and closely monitor market trends."

Bank of Korea Governor Lee Chang-yong also said on the 25th (local time) in Washington D.C., "The won-dollar exchange rate has risen much higher and faster than we want," and noted, "The exchange rate, which was not a consideration in the October Monetary Policy Committee meeting, has become a factor again in the November meeting."

Exchange Rate Nearing 1400 Won Threshold... Likelihood of Additional Rate Cuts This Year ↓

Some predict that the strong dollar trend could push the won-dollar exchange rate into the mid-1400 won range. This is due to external variables such as the U.S. presidential election and Middle East tensions, as well as South Korea's third-quarter real gross domestic product (GDP) announced on the 24th, which grew only 0.1% quarter-on-quarter, falling far short of the Bank of Korea's forecast (0.5%), and exports turning to a decline.

Park Sang-hyun, a researcher at iM Securities, explained, "Along with the strong dollar, the yen and yuan are also weakening, and combined with the third-quarter domestic GDP shock and net selling of domestic stocks by foreigners, the exchange rate's upward movement has expanded," adding, "This week, the won-dollar exchange rate band is expected to be between 1360 and 1420 won, with a possibility of attempting to enter the 1400 won range."

Jo Yong-gu, a researcher at Shin Young Securities, said, "If Trump wins the U.S. presidential election and the Republicans dominate, the exchange rate could reach 1420 won," and "The dollar index could rise from 104 to 106."

Choi Kyu-ho, a researcher at Hanwha Investment & Securities, said, "With the Fed's rate outlook being revised back, we should keep in mind a short-term level around the low 1400 won range," adding, "This week is critical as U.S. employment, manufacturing data, and third-quarter GDP announcements are expected, determining whether the exchange rate will exceed 1400 won."

If the exchange rate continues its upward trend, the Bank of Korea's Monetary Policy Committee is likely to keep the base interest rate unchanged next month.

Researcher Jo said, "The exchange rate reflects the growth rate and interest rate differential between Korea and the U.S., and the gap in growth between the two countries has widened significantly," adding, "With Korea's third-quarter GDP coming in low and the exchange rate unstable, a rate cut is more likely in January than in November."

Researcher Choi said, "Since the Bank of Korea cut rates in October, it is likely to hold rates steady in November while observing results," and evaluated, "Governor Lee's remark in Washington D.C. that it would have been a big problem if the rate cut cycle had been accelerated or widened too much suggests that the Bank will be cautious about additional cuts."