MNI STATE OF PLAY: BOK Guides To 25bp But Tested By Fed View

A more hawkish tone from Bank of Korea Governor Rhee Chang-yong has raised the odds of a 50bp hike at the Bank's October 12 meeting, with a possible backtrack on previous guidance for a "gradual" 25bp tightening sparked by a sharp fall in the won on expectations for higher-than-expected U.S rates.

While the BOK telegraphed the use of 25bp hikes at its August 25 meeting, the prospect of a higher terminal Fed funds rate has put a 50bp hike to 3% on the table as the won sunk to its lowest against the U.S. dollar since 2009 on widening interest rate differentials between the U.S. and South Korea.

Rhee last month said expectations for the Fed funds to stabilise around 4% had "changed a lot" in terms of the Bank's thinking on the monetary policy outlook, though he added that "no decision had been made." He had previously said the BOK would raise rates gradually over time, hiking it by increments of a quarter percentage point.

"Though the BOK is vigilant against a weak currency, which will boost inflation, it will not use monetary policy to curb currency weakness, said SMBC Nikko Securities chief emerging market economist Kota Hirayama.

“Excessive weakness of the KRW currency is undesirable but a weak currency is supportive to exports. The BOK, if necessary, will conduct forex intervention to out a brake on a rapid currency fall,” he said.

INFLATION EASING

Some economists believe the BOK will stick with a 25bp hike given the slowing pace of inflation. South Korea’s consumer price index rose 5.6% y/y in September, slowing from 5.7% in August and 6.3% in July, which was the highest level since November 1998 when it rose 6.8%.

“A 25-basis point hike is likely as inflation has peaked out and the outlook for its economy is gloomy in the wake of weak exports caused by sluggish demand for semiconductors,” a person who is familiar with its economy and monetary policy said.

The BOK raised interest rates by a quarter point at its last meeting to 2.5% and said further increases of 25bps "will be appropriate for some time as long as inflation paths remain as currently presumed."

“The BOK will likely raise the rate by 25 basis-point as the core inflation rate will likely stay at 4% or higher and as it takes time for the inflation rate to fall, although the year-on-year rise in headline inflation rate is likely to slow,” Hirayama said.

He said that the BOK will continue to raise the policy rate gradually, while paying attention to the risk of slowing the economy too much through rate hikes.

South Korea’s exports rose 2.8% y/y in September, slowing from a 6.6% pace in August, indicating weaker global demand that will place downward pressure on the economy. Overseas demand is slowing in the wake of rate hikes by major central banks, though domestic demand in South Korea is strong.

Hirayama said that the BOK continues to keep a close eye on the sustainability of low unemployment and whether exports will fall year-on-year. He forecast the BOK to raise its Base Rate to 3.5% in the first quarter of 2023.