US rate hike widens Korea-US gap to 1 percentage point, piling pressure on Bank of Korea

The Federal Reserve's first interest rate increase in more than three years — accompanied by signals of further hikes this year — is expected to reinforce the Bank of Korea's tightening monetary policy stance. With growth and inflation still running high, financial imbalances remaining unstable, and the won-dollar exchange rate facing upward pressure, attention is turning to whether the BOK's Monetary Policy Board will deliver a third consecutive benchmark interest rate increase at next month's meeting.

BOK Deputy Governor Kwon Min-su convened a market monitoring meeting Thursday morning following the outcome of the US FOMC meeting. He said the Fed had raised rates for the first time in more than three years since July 2023, and that "given Chair Kevin Warsh's emphasis on price stability and his signal of possible further hikes, the Fed's monetary policy stance is likely to remain restrictive going forward."

He added that the BOK would continue to monitor domestic financial and foreign exchange markets with heightened vigilance, citing lingering external risk factors — including developments in the Middle East war, international oil price movements, concerns over fiscal soundness in major economies, and uncertainty surrounding the AI industry. He also noted that monetary policy decisions by major central banks, including those of Japan and the United Kingdom, are scheduled this week.

In the early hours of Thursday, the FOMC raised its benchmark interest rate by 0.25 percentage points to a range of 3.75 to 4 percent, the first such move in roughly three years. All 12 FOMC members, including Chair Warsh, voted in favor of the increase, and the committee signaled the possibility of an additional hike before year-end — a development expected to add further weight to the BOK's tightening stance.

The dot plot released Thursday showed that 12 of the 19 FOMC participants projected the federal funds rate would end the year at 4 to 4.25 percent, a quarter-point above the current level, while four projected a range of 4.25 to 4.5 percent. Only two participants forecast no change. Chair Warsh did not participate in the dot plot. The median year-end rate projection among participants came in at 4.1 percent, up 0.3 percentage points from the June dot plot — a reading widely interpreted as pointing to at least one more hike this year.

The CME Group's FedWatch tool showed that only 11.3 percent of market participants expected the benchmark interest rate to remain at its current level through year-end. A majority — 50.1 percent — forecast a range of 4 to 4.25 percent, while the remaining 38.6 percent projected 4.25 to 4.5 percent.

The US rate increase and the prospect of further tightening are expected to lend additional momentum to the BOK's own restrictive stance. The BOK's Monetary Policy Board formally entered a rate-hiking cycle in July, raising the benchmark interest rate for the first time in roughly three and a half years, then followed up with another increase at its subsequent meeting and signaled the need for further action.

The most immediate domestic impact of the US rate hike is on the won-dollar exchange rate. A wider Korea-US interest rate differential increases upward pressure on the exchange rate, as a higher US rate strengthens the dollar and puts relative downward pressure on the won. The latest hike has widened the gap between the two countries' benchmark rates from 0.75 percentage points to 1 percentage point. Rising international oil prices have also been pushing the won-dollar rate higher in recent weeks.

The monthly average won-dollar rate — based on weekly closing prices — peaked at 1,528 won in June before falling consecutively to 1,488.9 won in July and 1,404.4 won in August. The September average through Wednesday had dropped further to 1,352.6 won. On a daily basis, however, the rate climbed for five straight trading sessions, rising from 1,336.1 won on Sept. 9 to 1,368.6 won on Wednesday. As of 9 a.m. Thursday, the won-dollar rate had advanced further to 1,378.3 won.

The simultaneous rise in the won-dollar rate and oil prices is expected to strengthen the case for a rate increase. Higher oil prices and a weaker won drive up import prices, which feed through to consumer prices with a lag. Key indicators including inflation and economic growth continue to run at elevated levels, adding to the pressure for further tightening. The BOK has repeatedly flagged demand-side price pressures centered on semiconductors, and a renewed rise in oil prices risks compounding that with supply-side inflation. Financial imbalances — including housing prices in the greater Seoul area and household debt exceeding 2,000 trillion won ($1.48 trillion) — also remain a source of concern.

The BOK is scheduled to hold its monetary policy direction meeting on Oct. 22 to set the benchmark interest rate. With major economies including the United States raising rates and economic indicators pointing toward further tightening, the possibility of a third consecutive rate hike is being raised.

However, some analysts expect the BOK to pause and assess the impact of its back-to-back increases last month, which broke with convention. Governor Shin Hyun-song said at a press briefing following last month's monetary policy meeting, "Because we raised rates consecutively this time, we need to examine the effects."

According to the minutes of last month's Monetary Policy Board meeting released by the BOK, one board member said the benchmark interest rate policy "should keep open the possibility of further hikes, taking into account inflationary pressures and financial stability risks that could persist beyond next year," while also stressing that "the timing of any increase must be decided in a way that does not impose an unbearable burden on economic actors who have yet to fully feel the benefits of improving conditions."