Korean Won in Freefall

The won closed down another W13.3 against the U.S. dollar on Thursday to W1,288.6, the weakest in 13 years. The U.S. Fed is rushing to hike interest rates to curb the highest inflation in 41 years, which is rattling financial markets around the world and strengthening the dollar.

Last week, the Fed raised the key interest rate by 0.5 percentage point, twice the usual increase, for the first time in 22 years and is expected to hike it further. That means that the dollar's strength will continue and the export-dependent Korean economy will be subjected to growing uncertainties and inflation.

But the main reason for the weakening won is jitters over the global economic outlook that are driving investors to safe-haven assets like the dollar. Analysts forecast the won will remain weak for the time being.

Another threat is an exodus of foreign capital if U.S. interest rate rises above Korea's. At present, the U.S. federal funds rate is between 0.75 percent to one percent, compared to 1.5 percent in Korea, but the U.S. rate could catch up even if the Bank of Korea raises the key rate twice more by 0.25 percentage point each.   

The BOK has already hinted at further hikes to prevent an exodus of foreign capital, but that could put the brakes on economic growth and reduce hiring.

Korea's household debt, which stands at W1.86 quadrillion, is a major factor preventing the BOK from taking bold measures. If loan interest rates increase just one percentage point, that will increase the interest households have to pay by almost W20 trillion a year, prompting a growing number to default on their loans.

Sung Tae-yoon at Yonsei University said, "The economy has already entered a stage of stagflation."

Kim Jung-sik at Yonsei University said, "We urgently need to improve the trade balance and defend the currency."

Signing a currency-swap deal with the U.S. could ease market jitters. Korea's last currency-swap agreement with the U.S., which was signed just after the coronavirus pandemic started, expired at the end of 2021.