Korea-U.S. interest rate gap widens to all-time high after Fed takes baby step

Bank of Korea in central Seoul [JOINT PRESS CORPS]

The interest rate gap between the Bank of Korea (BOK) and the U.S. Federal Reserve (Fed) has widened to a new high of 1.75 percentage points after the Fed took another baby step and raised the benchmark rate by 0.25 percentage point on Wednesday.

The U.S. Fed raised its rates by 0.25 percentage point to bring them to 5.00~5.25 percent from 4.75~5.00 percent during the Federal Open Market Committee (FOMC) meeting this week. The Fed increased the rates by a quarter point for three times in a row to tackle inflation despite the collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank.

Market insiders project that this would be the final hike by the Fed given that the phrases such as “additional tightening would be appropriate” were removed from the FOMC statement.

U.S. Fed Chair Jerome Powell, however, denied the possibility of a rate cut, saying that “inflation is going to come down not so quickly.”

“It will take time,” he said. “If the forecast is broadly right, it would not be appropriate to cut rates.”

The latest hike by the Fed, albeit a baby step, has widened the rate gap with Korea to a new high of 1.50~1.75 percentage points, raising concerns about capital outflow.

Korea’s base rate stands at 3.50 percent.

BOK Governor Rhee Chang-yong has emphasized several times that he will not “mechanically respond to the Korea-U.S. interest rate gap” but critics note that it will be impossible to ignore the won’s depreciation against the greenback and foreign capital outflow.

The BOK will have to consider raising the benchmark rates further if the won-dollar exchange rate that exceeded the 1,300 won threshold goes further up because of the interest rate gap.

The won’s weakening may heat up inflation as it will lead to higher domestic prices of the same import items.

Five of the monetary policy board members of the BOK have already stated during the meetings in February and April that they are open to the possibility of raising the rate to 3.75 percent.

The market, however, still bets that the BOK will freeze the rates on May 25 given that there are no major changes in the exchange rate and foreign capital trends.

The Korean economy has been covered with dark clouds amid growing uncertainty in the financial market.

Korea’s real gross domestic product (GDP) gained only 0.3 percent in the first quarter. It also logged a current account deficit for two straight months in January and February, the first time in 11 years. The trade balance logged a deficit for a 14th month in April.

Korea’s inflation, in the meantime, softened to 3.7 percent in April, going below the 4 percent range for the first time in 14 months.