Fed Set to Reopen the Rate Gap the Bank of Korea Narrowed Twice
Stronger-than-expected U.S. inflation and employment data have raised the likelihood that the Federal Reserve (Fed), the U.S. central bank, will raise its benchmark rate—the representative rate set by a central bank—at its meeting this month. The Fed will convene the Federal Open Market Committee (FOMC) on the 15th and 16th (local time) to set the rate, and new economic projections will be released at the same meeting. The U.S. benchmark rate currently stands at 3.50 to 3.75 percent. According to CME Group's FedWatch, the odds of a 0.25-percentage-point hike at the September FOMC climbed from 60 percent a week earlier to about 73 percent the day before, and then to 85.8 percent immediately after the consumer price release on the 11th. The yield on two-year U.S. Treasuries also rose to 4.613 percent, a 52-week high.
The employment data have given the Fed room to tighten. Nonfarm payrolls grew by 162,000 last month, far exceeding the average monthly gain of 31,000 over the past 12 months, according to the U.S. Department of Labor. The unemployment rate held at 4.1 percent.
Price pressures are building on both the production and consumption sides. The producer price index rose 0.4 percent from the previous month and 5.4 percent from a year earlier, with energy prices jumping 4.2 percent in one month. Consumer prices climbed 0.4 percent from the previous month and 3.4 percent from a year earlier. Core CPI, which excludes food and energy, rose 0.3 percent, above the market forecast of 0.2 percent, for an annual gain of 2.4 percent.
The impact will spill over into Korea. If the Fed raises rates, the U.S.-Korea benchmark rate gap that the Bank of Korea narrowed with two consecutive hikes will widen again. The BOK lifted its benchmark rate by 0.25 percentage points in July and again on the 27th of last month, bringing it to 3.00 percent and narrowing the gap with the United States—measured against the top of the U.S. range—to 0.75 percentage points. A Fed hike this time would put the U.S. benchmark rate at 3.75 to 4.00 percent, reopening the gap at 1.00 percentage point.
The currency market is shifting as well. The won-dollar exchange rate fell to an intraday low of 1,334.7 won on the 7th of this month before rebounding to 1,345.9 won on the 11th.
High oil prices and the weak won are shaking up the inflation outlook. Episodes in which oil prices and the exchange rate rise together push up import prices. Korea, which relies on imports for most of its crude oil, must spend more won to bring in the same volume of crude when both variables climb. Those costs feed into producer prices through petroleum products and transportation costs, then pass through to consumer prices with a lag.
When it raised rates last month, the Bank of Korea explicitly cited oil prices and the exchange rate as key uncertainties in the inflation path. It projected consumer inflation at 2.7 percent this year and 2.3 percent next year, above its 2 percent target for a considerable period. It also estimated that a prolonged Middle East standoff would push inflation 0.1 percentage point higher this year and 0.4 percentage point higher next year than the baseline forecast.
In August, the BOK judged that growth was running stronger than expected on robust exports and a recovery in domestic demand, saying it would decide the timing and pace of further hikes in light of inflation, economic conditions, and financial stability. At last month's Monetary Policy Committee meeting, six of the seven members voted for the hike, while one argued that keeping the benchmark rate at 2.75 percent was preferable. The BOK's next rate decision meeting is scheduled for the 22nd of next month.
