BOK Hikes Interest Rate After Won Plummets to Historic Low

The Bank of Korea on Wednesday hiked the key interest rate by an unprecedented 0.5 percentage point to 2.25 percent in order to tame inflation and prevent the U.S. benchmark rate from surpassing Korea's.

The U.S. Federal Reserve is expected to raise its base rate yet again this month. BOK Governor Rhee Chang-yong forecast that Korea's base rate will end up somewhere between 2.75 and three percent by the end of this year.

He added he will talk about currency swap agreements to stabilize the Korean currency when he meets with U.S. Treasury Secretary Janet Yallen in Seoul next week.

The decision came after the Korean won plunged another W8.20 against the U.S. dollar on Tuesday at W1,312.10, the weakest since July 13, 2009 in the aftermath of the Asian financial crisis.

The won plunged to W1,316 against the greenback at one point during intraday trading as the dollar and euro reached parity for the first time in 20 years.

The won has lost more than 10 percent to the dollar so far this year, increasing the risks faced by the Korean economy. Global inflation has sent the prices of crude oil and raw materials skyrocketing, forcing Korea to spend huge amounts of money to import them. That resulted in a record trade deficit of $15.90 billion so far this year.

The global recession has whetted investor appetite for safe-haven assets like the dollar, which means the won is likely to weaken further. Another factor boosting the dollar is the fact that China, Japan and EU continue to maintain low interest rates.

Korea's foreign currency reserves, which serve as ammunition against a rapid depreciation of the won, are dwindling rapidly.

According to the Bank of Korea, Korea's forex reserves have fallen by $9.43 billion over the last month to $438.28 billion, the fastest monthly rate of decline in 13 years and seven months. But the BOK said, "Korea still ranks ninth in the world in terms of its foreign currency reserves, which is sufficient to defend it against external shocks."