Rhee Chang-yong: "If the FX rate feeds into inflation, we will consider raising rates"…Korea’s government bond yields jump into the 3% range

BOK deletes wording on a ‘base rate cut’…effectively signaling the end of the easing cycle

Rhee: "The won is undervalued relative to fundamentals

About 75% is due to external factors such as a strong dollar and a weak yen"

Five of six MPC members: "Hold for the next three months"

The Bank of Korea’s decision on the 15th to keep the base rate unchanged at an annual 2.50% was widely seen as driven primarily by the exchange rate. Markets assessed that the easing cycle has effectively ended, citing factors such as the disappearance of the phrase “rate cut” from the policy statement. Korean government bond yields surged after BOK Governor Rhee Chang-yong even raised the possibility of a “rate hike.”

At a press briefing after the Monetary Policy Committee meeting on monetary policy direction held at the BOK’s headquarters on Namdaemun-ro in Seoul, Rhee stressed that “it is an undeniable fact that the exchange rate was a key reason behind the decision.” He added, “The won–dollar rate fell by more than 40 won from the end of last year, but has risen again this year to the mid-to-late 1,400-won range, so we need to maintain a high level of vigilance.”

Rhee said much of this year’s rise in the exchange rate reflects global currency trends. “About three-quarters is due to a strong dollar, a weak yen and geopolitical risks, and the remaining roughly one-quarter is due to domestic factors (supply and demand),” he said. In his view, the situation differs from last year, when Korea’s exchange rate rose even as the dollar weakened.

He said that “any economist would know that a move to close to 1,480 won per dollar cannot be explained by the fundamentals of the Korean economy,” while also noting that “supply-and-demand factors beyond fundamentals are also playing a significant role.” He added, “The won is undervalued relative to fundamentals,” and said, “There is a need to change expectations that the exchange rate will rise.”

The rate hold was a unanimous decision by MPC members. Shin Sung-hwan, who had issued a dissenting opinion calling for a rate cut since last August, also changed his view. Forward guidance also turned more hawkish, with five of the six MPC members saying it would be appropriate to keep rates on hold for the next three months. The number of members leaning toward a three-month hold was just one last August, rising to two in October, three in November and five this month.

Rhee said, “For the next three months, most members see maintaining a hold stance,” adding that the view was “to decide which direction to take after that—six months later—based on the data.”

He also mentioned the possibility of raising rates. “If the exchange rate stays high and affects inflation, we would have to raise rates,” he said. However, he added, “To curb the exchange rate with interest rates, a 0.25%-point hike would not be enough; it would take 2–3% points, which could cause a lot of people to suffer,” and said it was “something to be judged after considering all factors.”

Bond yields jumped on the hawkish outcome. In the Seoul bond market, the three-year Korea Treasury Bond yield ended the day at 3.090%, up 0.094% points. Kim Myung-sil, a researcher at iM Securities, said, “If there are no major surprises in the key variables the BOK is watching (growth, inflation and financial stability), the easing cycle has effectively ended.”

By Kang Jin-kyu josep@hankyung.com