The recent surge in oil prices due to the Middle East conflict has effectively eliminated expectations for a Federal Reserve (Fed) rate cut. This development is putting pressure on the Bank of Korea (BOK) to either maintain its current interest rates for an extended period or consider raising them.
The probability of the Fed keeping rates steady in the first half of the year has soared from 42.7% to 92.2%. Likewise, the chances of maintaining this rate until year-end have jumped from 3.9% to 72.4%. Inflation concerns driven by high oil prices, coupled with a strong dollar, are exacerbating the KRW depreciation and increasing inflationary pressures. This could potentially limit the BOK’s ability to ease monetary policy.
Fed Rate-Hold Odds Surge to 92%… Year-End Hold Expectations Jump from 3.9% to 72.4%
A report released on Tuesday by the International Financial Center, titled, Assessing U.S. Dollar Trends Under Various Middle East War Scenarios, indicates that the likelihood of the Fed maintaining current rates until June has skyrocketed from 42.7% at February’s end to 92.2% as of March 31.
The probability of rates remaining unchanged until year-end also saw a significant increase during the same period, jumping from 3.9% to 72.4%.
The International Financial Center explained that inflation concerns stemming from rising oil prices have rapidly diminished market expectations for a Fed rate cut.
The Fed’s interest rate decisions directly impact the BOK’s monetary policy. A widening interest rate gap between the U.S. and South Korea could trigger capital outflows and further weaken the won, potentially leading to higher import prices.
As external interest rate environments gain more influence, the BOK’s Monetary Policy Committee is set to make its first interest rate decision since the outbreak of the Middle East conflict on April 10.
Given the uncertainty surrounding the war’s impact on prices and economic growth, the prevailing market expectation is that the BOK will maintain its current rate at 2.50% per annum.
However, if the conflict persists, ongoing high oil prices and a strong dollar could necessitate a shift in policy direction during the latter half of the year.
Rising global oil prices strengthen the dollar and contribute to the won’s depreciation, intensifying consumer price pressures. Analysts suggest this scenario would inevitably constrain the BOK’s ability to ease monetary policy.
Jo Yong-gu, an analyst at Shin Young Securities, predicts the BOK will raise rates once (by 0.25 percentage points) this year. He noted that the fading expectations for a Fed rate cut are significantly reflected in the pressure for a stronger USD.
Jo added that this will likely continue to be a negative factor, and even if a ceasefire occurs or the Strait of Hormuz fully reopens in the short term, it’s unlikely that the exchange rate will rapidly return to pre-war levels.
Oil, a Key Monetary Policy Variable, Could Top 100 on Average USD… Trump’s 8-Day Deadline Seen as Turning Point
With oil prices identified as a critical factor in monetary policy, the International Financial Center presented three scenarios. Depending on how the conflict unfolds, oil prices could average between 70-80 USD (S1), 90-100 USD (S2), or exceed 100 USD (S3) per barrel.
Analysts suggest that if oil prices surpass 80 USD, the likelihood of the BOK raising interest rates increases, indicating a potential shift in monetary policy stance should the conflict persist.
The pivotal moment in these scenarios is the deadline set by President Donald Trump for negotiations with Iran.
Recently, Trump extended the negotiation deadline (8:00 p.m. Eastern Time on Tuesday), ratcheting up the pressure. He warned that if they take no action by Tuesday evening, there will be no power plants left standing, and no bridges will remain.
The International Financial Center noted that tensions are likely to either ease (S1) or escalate into a broader conflict (S3) around this deadline.
Oil price trajectories diverge significantly based on the war scenarios.
In the escalation scenario (S3), where the conflict continues into the second half of the year with additional infrastructure damage, oil prices could surge to 150 USD, resulting in an ultra-high price environment averaging over 100 USD per barrel.
The extended war scenario with limited openings (S2) projects oil prices to remain elevated, averaging 90-100 USD, while the Fed is expected to implement only one rate cut in the latter half of the year. In this case, the dollar is anticipated to maintain limited strength due to safe-haven demand and improved trade conditions.
Conversely, the de-escalation scenario (S1), assuming a ceasefire by mid-next month, forecasts oil prices stabilizing around 70-80 USD, with the Fed likely to make one or two rate cuts within the year. However, analysts caution that even if shipping through the strait resumes, it would take at least a month for cargo volumes to normalize, limiting the potential for a sharp drop in oil prices.
Yoon Yeo-sam, an analyst at Meritz Securities, emphasized that oil prices are the most critical variable. He added that if prices remain around 100 USD until the May monetary policy meeting, the BOK may need to signal a rate hike. Analyst Jo concurred, stating that if Brent crude averages over 80 USD per barrel, the likelihood of a rate hike increases significantly.
