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Fed's hawkish pause on rates burdens Korean economy

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U.S. Federal Reserve Chairman Jerome Powell takes questions from reporters during a press conference after the release of the Fed policy decision to leave interest rates unchanged at the Federal Reserve in Washington D.C. Wednesdsay. Reuters-Yonhap

Experts concerned about possible capital flight due to widening rate gap
By Yi Whan-woo

The Korean economy appears destined to continue experiencing the negative impact of high U.S. interest rates following the U.S. Federal Reserve's hawkish pause on its policy rates, according to analysts, Thursday. The Fed on Wednesday left its benchmark lending rates unchanged at a range of 5.25 percent to 5.5 percent for the second straight meeting since July.

Fed Chair Jerome Powell, however, said the U.S. central bank still has "a long way to go" in bringing down inflation to its target of 2 percent and signaled an additional rate hike this year. The comments reflect the Fed's commitment to fight inflation, while taking a break from raising interest rates in order to assess the impact of its past rate hikes.

After falling from 6.4 percent to 3 percent from January to June, U.S. inflation accelerated to 3.2 percent in July and to 3.7 percent in August due to surging crude oil prices.

The U.S. rate currently stands at a 22-year high, with the interest gap with Korea's 3.5 percent rate remaining at a record high.

The Fed chair's comments were accompanied by its Summary Economic Projections.

An additional 25 basis point rate hike is anticipated this year, pushing the U.S. base rate to peak at a range of 5.50 percent to 5.75 percent.

Under the circumstances, experts in Seoul expressed concerns that a possible U.S. rate increase can dampen Korea's efforts to revitalize its sluggish economy in the second half of the year.

"The outflow of foreign capital can be worrisome, although such an outflow is not affecting the economy so far," said Hana Bank researcher Seo Jung-hoon.

He was referring to a conventional market belief that a higher U.S. interest rate than Korea's would lead to a capital flight in search of safe-haven assets, and subsequently, a sharp depreciation of the Korean won against the U.S. dollar.

The Korean currency has remained in the lower 1,300 won level per dollar this month, gaining ground from the 1,400 won level from a year earlier, but still weaker than the 1,100 won range witnessed before the Fed began its rate-hike campaign in March 2022.

The Fed has lifted interest rates 11 times since then and held them steady twice, including September's pause.

Lee Sang-ho, head of the economic policy team at the Korea Economic Research Institute (KERI), said the weakened value of the Korean won driven by high U.S. interest rates can increase the cost of imports.

He noted that a considerable proportion of Korea's imports are energy and raw materials, which suggests that "export costs would also increase and end up making Korean products sold on the international market more expensive."

Concerning the Bank of Korea's (BOK) rate policy, Joo Won, deputy director of the Hyundai Research Institute, viewed the high U.S. interest rates will "hold the BOK back from starting to lower rates" to increase money supply in the market.

"The BOK rather will need to consider resuming rate hikes to ensure the Korea-U.S. interest rate gap stays as close as possible," he said, noting the BOK kept its rate steady at 3.5 percent since January.

Yi Whan-woo


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