Korea-U.S. interest gap widens to 1%p after Fed hike

The gap between the U.S. policy rate and South Korea’s benchmark rate has widened back to 1 percentage point after the Federal Reserve raised its rate.

Deputy Prime Minister and Minister of Finance and Economy Koo Yun-cheol convened an expanded macroeconomic and financial policy meeting on Thursday following the Fed’s decision announced Wednesday local time.

The meeting was attended by Bank of Korea (BOK) Governor Shin Hyun-song, Financial Services Commission Chairman Lee Eog-weon, and Financial Supervisory Service Governor Lee Chan-jin.

Participants said the Fed raised its policy rate amid solid economic and employment conditions, elevated inflation, higher international oil prices and increased geopolitical uncertainty. They said the hike was largely priced into markets and had limited immediate impact on Korea, as financial markets remained broadly stable.

They also noted the Fed’s stronger commitment to price stability while leaving open the possibility of another rate hike this year. Participants agreed to closely monitor monetary policy decisions by the Bank of Japan and Bank of England scheduled for this week.

The prospect of further Fed rate hikes could increase pressure on the BOK to tighten policy. Inflation concerns remain as the wider U.S.- Korea rate gap puts downward pressure on the won and oil prices remain high.

Housing price instability in the Seoul metropolitan area is another factor that could add to inflationary pressure.

Economic data are also adding to inflationary pressure.

Nominal gross domestic product (GDP) grew 26.4 percent in the second quarter from a year earlier, the fastest growth since the 27.7 percent increase recorded in the third quarter of 1979.

The BOK said earlier this month that consumer price inflation was expected to continue rising in September, adding to evidence of persistent price pressures.

Against this backdrop, some analysts expect the BOK to bring forward a rate hike to 3.25 percent, citing the risk that a weaker won could add to inflationary pressure after its recent strength helped offset higher oil prices. The won’s exchange rate and financial market conditions are expected to be key factors in next month’s policy decision.

Still, the prevailing view is that the BOK will raise its policy rate in November. The Monetary Policy Board raised rates in July and August and may wait to assess the effects of those increases. In its most recent policy decision, the board removed language saying that “monetary policy needs to continue on a rate-hike path,” signaling a slower pace of tightening.

Meanwhile, the macroeconomic and financial policy meeting also covered the government bond market, where volatility has increased amid changes in domestic and external conditions, including the Fed’s rate hike.

Participants agreed to closely monitor the market as uncertainty could persist, while the government would take measures to stabilize it if market concentration or one-sided positioning becomes excessive.