The Bank of Korea faces a complex monetary policy landscape as the Federal Open Market Committee (FOMC) meeting approaches next week.
With U.S. Treasury yields flirting with 5% and oil prices surpassing 100 USD per barrel, the higher-than-expected U.S. core Consumer Price Index (CPI) for August has reignited speculation about potential Federal Reserve rate hikes. Such moves could fuel domestic inflation through a stronger dollar and weaker won, while rising U.S. long-term rates might tighten South Korea’s financial conditions, further complicating the Bank of Korea’s policy decisions.
The Bank of Korea’s Monetary Policy Committee recently raised the benchmark rate to 3.00% for the second consecutive month. However, they’ve indicated that October’s decision will hinge on economic and financial conditions assessed just before the meeting. This makes the upcoming FOMC outcome, along with subsequent trends in global oil prices, exchange rates, and market interest rates, critical factors in shaping the Bank’s future rate trajectory.
Oil at 100 USD, U.S. Treasury yields near 5%, and high core CPI fuel FOMC tightening concerns
Treasury market data from the 14th shows that the 10-year U.S. Treasury yield hit 4.98% on the 11th, its highest level since October 2023 (4.99%).
International oil prices have also rebounded. Escalating U.S.-Iran tensions have pushed both West Texas Intermediate (WTI) and Brent crude above 100 USD per barrel.
These developments have intensified market focus on the September 15-16 FOMC meeting. Surging oil prices have rekindled inflation fears, while rapidly rising market rates have put the Fed’s potential for further tightening back in the spotlight.
Shinhan Investment analysts Kim Chan-hee and Ko Da-young note that WTI’s return to triple digits has increased the likelihood of a rate hike at the September FOMC.
The higher-than-expected U.S. core CPI for August also bolsters the case for tightening. Released on September 11, the core CPI rose 0.3% month-over-month, surpassing the 0.2% forecast.
This marks the final inflation report before the FOMC meeting on September 15-16.
Following the CPI announcement, market participants ramped up their bets on a rate hike.
The CME FedWatch tool shows that the probability of a 0.25 percentage point rate hike at next week’s FOMC meeting jumped from 72.4% to 86.3% by afternoon. Just a week earlier, on September 4, it stood at 59.4%.
Even if the Fed holds rates steady but signals potential future hikes, it puts pressure on the Bank of Korea. Strong U.S. tightening expectations could strengthen the dollar and weaken the won, potentially driving up consumer prices through higher import costs.
The rise in long-term U.S. interest rates is another key variable for the Bank of Korea to monitor.
If U.S. Treasury yields pull up domestic long-term rates, it could increase financing costs for households and businesses, effectively tightening financial conditions even without a Bank of Korea rate hike.
Shinhan Investment analysts project the 10-year U.S. Treasury yield to fluctuate between 4.85% and 5.05%.
High global oil prices further complicate the Bank of Korea’s policy decisions, as they directly fuel domestic inflationary pressures.
Elevated oil prices eventually filter through to import prices and fuel costs, which then ripple through transportation and production costs to processed goods and service prices.
The Bank of Korea is closely monitoring the potential impact of rising oil prices on future inflation.
Kwon Beop-jun, head of the Bank of Korea’s Economic Trends Team, noted at a recent press briefing that while the won’s recent appreciation may exert downward pressure on import prices, rising oil prices remain a concern.
He added that it expects the cumulative effects of oil price shocks to transfer to demand-side price pressures. Considering these factors, it anticipates inflation will remain elevated.
KB Securities analyst Im Jae-kyun identified international oil prices as the primary concern. While the won’s recent strength has partially offset rising oil prices, he warned that prolonged U.S.-Iran tensions could reignite inflationary pressures if oil prices remain high.
October Rate Hike Unlikely, But Year-End Increase Possible If Oil and U.S. Rates Climb
While a third consecutive rate hike in October seems unlikely, persistent increases in global oil prices and U.S. long-term interest rates could raise the odds of additional hikes later this year.
Monetary Policy Committee member Kim Jong-hwa has emphasized the need to evaluate the impact of the previous two rate increases, suggesting caution about a third consecutive hike.
Analyst Im also noted that the current 3.00% benchmark rate exceeds the estimated neutral rate range, indicating a need to assess recent hike effects and lowering the probability of an October increase.
However, two more rate decision meetings remain this year, scheduled for October 22 and November 12.
Market observers suggest that prolonged high oil prices could accelerate the timeline for potential rate hikes.
Analysts Kim and Ko previously projected the next rate hike for early 2024, but now suggest it could occur in Q4 2026 if oil prices remain above 90 USD per barrel in October.
Their baseline scenario assumes gradual energy price stabilization as Middle East tensions ease. However, persistently high oil prices could reignite concerns about secondary inflation effects, potentially necessitating further Bank of Korea tightening.
Recent won appreciation has somewhat cushioned the impact of rising oil prices. However, if the Fed signals further tightening at next week’s FOMC meeting, renewed dollar strength could erode this buffer.
However, if the Fed decides to implement another rate hike or strongly indicates the possibility of future tightening at next week’s FOMC meeting, dollar strength could resume, potentially weakening this buffering effect.
