Impact of rate hikes
Time to prepare for US monetary tightening
The Korean won showed its weakness against the U.S. dollar last week as the U.S. Federal Reserve signaled that it may raise its policy rate earlier and faster than previously expected to combat spiking inflation. The problem is that a stronger dollar could destabilize the local financial market and deal a setback to the Korean economy.
On Friday, the Korean currency fell to 1,201.50 won per U.S. dollar after breaking the 1,200 won level the previous day, for the first time since July 24, 2020. Market watchers predicted that the won’s downward march will continue as the Fed’s faster monetary tightening looms large.
According to minutes from the Fed’s December policy meeting released Wednesday, Fed officials hinted at earlier and faster interest rate hikes than had been anticipated. They implied that the U.S. central bank could raise the federal funds rate three times this year from the current level of near zero.
The Fed might start ramping up its policy rate as early as March after ending its asset purchase program that was aimed at stimulating the pandemic-hit economy. This could mark a shift from the Fed’s accommodative policy toward monetary tightening in order to bring the soaring inflationary pressure under control.
If such aggressive rate hikes become a reality, the U.S. currency will inevitably be stronger against other currencies. This could prompt a capital flight from emerging market countries to America. A further appreciation of the dollar could also create turmoil in stock markets and other financial markets around the world.
South Korea, for its part, should increase its interest rate further in a desperate bid to prop up the value of its currency. The Bank of Korea (BOK) already raised its key rate twice last year — by 0.25 percentage points each in August and November — to 1 percent. The rate hikes were designed to tame higher consumer prices which surged to 3.2 percent in October and 3.7 percent in November.
The U.S. move toward monetary tightening is feared to bring instability to the Korean financial market. It is also likely to weigh down on the Korean economy which is heavily dependent on exports. A weaker Korean won could boost the price competitiveness of Korean-made goods such as cars and electronics in oversea markets. But it could bring losses to steel, airlines and some other industries.
Amid global supply chain disruptions, a stronger dollar will certainly raise the import prices of crude oil, raw materials and parts for Korea. In turn, it will also accelerate inflation. Further rate hikes will be inevitable, but they will increase the debt payment burden on businesses and individuals. Household debt hit a record high of 1,850 trillion won ($153 billion) last year, becoming a ticking time bomb.
The government and the central bank should take preemptive measures to minimize the side effects of monetary tightening. They also need to go all-out to speed up economic recovery in order to improve the people’s livelihoods.