Key Moments
- The Bank of Korea lifted its policy rate by 25 bps to 2.75%, its first increase in three-and-a-half years.
- USD/KRW slipped toward 1,484.68 in Asian trading as the Won strengthened following the decision.
- Market-implied odds of a July Federal Reserve rate hike dropped to 10.2% from 31% a week earlier as US inflation softened.
BoK Rate Hike Supports Won
The South Korean Won (KRW) edged higher against the US Dollar (USD) after the Bank of Korea (BoK) raised interest rates for the first time in three-and-a-half years. The central bank increased its policy rate by 25 basis points to 2.75%, a move that had been widely anticipated as an effort to counter sustained inflationary pressures.
In Asian trading on Thursday, the USD/KRW pair surrendered earlier gains and moved lower, trading near 1,484.68 as investors responded to the BoK decision and guidance.
Forward Guidance and Inflation Focus
The BoK signaled that additional tightening remains possible as it seeks to stabilize the currency and contain price growth. Policymakers indicated they are prepared to act further if needed to bring inflation back toward target.
“We will respond until inflation stabilizes to BoK’s target level,” BoK Governor Hyun-Song Shin said in a statement. Shin added, “Demand side price pressure may need careful monitoring as it can turn into stronger inflationary pressure if robust increase in Gross Domestic Income (GDI) sustained.”
The Won has been outperforming the US Dollar for more than two weeks, reflecting positioning by market participants who had already been factoring in the likelihood of a BoK rate increase.
US Dollar Attempts to Rebound
While the Won strengthened, the US Dollar was trying to recover after a sharp pullback over the prior two sessions. The US Dollar Index (DXY), which tracks the performance of the Greenback against six major peers, traded slightly higher around 100.50 at the time of writing.
The DXY had dropped substantially in the preceding two trading days as softer United States inflation data at both the retail and wholesale levels led traders to reassess the outlook for Federal Reserve policy.
Fed Expectations Shift on Softer US Inflation
Market-based expectations for another Federal Reserve rate increase eased notably. According to the CME FedWatch tool, the probability of a rate hike at the Fed’s July meeting fell to 10.2%, down from 31% a week earlier, following the release of the latest US inflation readings.
| Indicator / Decision | Latest Level / Move | Context |
|---|---|---|
| BoK policy rate | 2.75% | Increased by 25 bps, first hike in three-and-a-half years |
| USD/KRW | Near 1,484.68 | Pair moved lower as Won strengthened in Asian trade |
| US Dollar Index (DXY) | Near 100.50 | Trading marginally higher after a sharp two-day decline |
| July Fed hike probability (CME FedWatch) | 10.2% | Down from 31% a week earlier |
Background: US Dollar and Fed Policy
Role of the US Dollar
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022.
Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
Federal Reserve Policy and the Dollar
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
Quantitative Easing (QE)
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
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