The U.S. Federal Reserve (Fed) cut the benchmark interest rate by 0.25 percentage points as expected, but signaled a moderation in the pace of rate cuts next year, showing a hawkish (preference for monetary tightening) stance. Following this decision, the dollar strengthened, and the won-dollar exchange rate surged to 1,450 won, indicating deepening domestic financial instability. The Bank of Korea, under pressure to cut its benchmark rate to stimulate the economy, is expected to face more complex challenges.
◇ U.S. Fed cuts benchmark rate to 4.25~4.50% by 25bp
The Fed announced at the Federal Open Market Committee (FOMC) meeting held on Dec. 17-18 (local time) that it would lower the benchmark interest rate to 4.25~4.50%, down 0.25 percentage points from the previous rate. This marks the third consecutive cut following a rate reduction of 0.5 percentage points in September, transitioning its monetary policy for the first time in four and a half years. The interest rate gap with Korea's benchmark rate (3.00%) has narrowed from 1.75 percentage points to 1.5 percentage points.
Although the benchmark interest rate was lowered, the market assessed the Fed's decision as hawkish (favoring monetary tightening). This is because the Fed's dot plot (a chart that aggregates the interest rate forecasts of Fed Commissioners) raised the year-end interest rate forecast from 3.4% to 3.9%. Assuming rates are cut by 0.25 percentage points each time, it implies the number of rate cuts next year would reduce from four to two.
Changes in the Fed's tone were also reflected in the policy statement and Fed Chair Jerome Powell's press conference. The phrase 'in considering further adjustments to the policy rate' in the previous policy statement was adjusted to 'in considering the size and timing of any further adjustments to the policy rate.' Fed Chair Jerome Powell also hinted at a moderation in the pace of rate cuts by stating, 'From now on, it would be appropriate to closely monitor inflation developments and cautiously decide on rate cuts.'
Reflecting the changed atmosphere, the dollar is showing strength. According to Investing.com, the dollar index, which shows the value of the dollar against the currencies of six major countries, recorded 108.09 as of 9:59 a.m. It is the first time since early November 2022 that the dollar index has exceeded the 108 mark. The dollar-yen exchange rate surged to the highest level in a month, surpassing 154.8 yen, and the dollar-yuan exchange rate also exceeded 7.30 yuan for the first time since Oct. 29 (7.30).
Meanwhile, the domestic financial market is in turmoil. On the 19th, the won-dollar exchange rate opened at 1,453 won, up 17.5 won from the previous transaction day closing price (as of 3:30 p.m.) and surpassed 1,450 won. The exchange rate exceeding 1,450 won is the third occurrence since the International Monetary Fund (IMF) financial crisis and the global financial crisis. The national treasury bond market also remains weak. As of 9:45 a.m. on this day, the three-year national treasury bond yield recorded 2.61%, up 8 basis points from the previous transaction day closing price (2.53%). Bond yields and prices move inversely, meaning that rising yields indicate falling prices.
◇ Challenges ahead for the Bank of Korea in rate decision amid economic slowdown concerns
The Bank of Korea's calculations have become complex ahead of its rate decision on Jan. 16. While maintaining the rate would be appropriate considering the expanded financial instability due to the Fed's 'hawkish cuts,' it cannot ignore concerns about economic slowdown amid recently heightened domestic political uncertainties.
According to the Bank of Korea, domestic consumer sentiment has significantly declined following the imposition of martial law and the passing of the impeachment bill. The news sentiment index (NSI), which is assessed to lead major real economy indicators by about 1 to 2 months, recorded 77.47 on Dec. 11. This is the lowest level in nearly two years since Dec. 2, 2022 (77.32), when the aftermath of the Legoland debt crisis lingered.
Another leading indicator, the average daily credit card spending, is also on a downward trend. The average daily spending in December was tallied at 2,479.6 billion won, down about 170 billion won from the previous month's 2,658.4 billion won. Even after excluding seasonal factors, the year-on-year growth rate also shows a decline. The growth rate of card spending decreased from 3.28% in November to 3.00% in December.
The weakened consumer sentiment is likely to have a negative impact on South Korea's economic growth rate. Lee Chang-yong, the Governor of the Bank of Korea, lowered this year's economic growth rate forecast from the previous 2.2% to 2.1% at the 'Price Stability Target Situation Inspection' press briefing held at the Bank of Korea headquarters on the 18th. He also anticipated that the growth rate forecast for next year, initially presented at 1.9%, could decrease by about 0.06 percentage points.
With the combination of financial instability and concerns over an economic slowdown, experts' forecasts on the Bank of Korea's rate decision are divided. Park Sang-hyun of iM Securities Research Institute said, 'Although financial uncertainty has increased, I think the Monetary Policy Committee in January might not lower rates,' noting that 'economic uncertainty has grown as the supplementary budget formulation and other economic stimulus policies have been delayed.'
Jo Yong-gu of Shinyoung Securities Research Institute said, 'Until the 18th, I thought Governor Lee Chang-yong had signaled a rate cut at the January Monetary Policy Committee, but there could be a change in thinking as new news (the Fed's hawkish cuts) has been conveyed.' He commented, 'While the possibility of a rate cut in January seems high for now, the timing of any additional cuts may be delayed.'
On the other hand, Kang Seung-won, head of the bond strategy team at NH Investment & Securities, said, 'The Bank of Korea's rate cut is expected to start in February,' adding, 'Since Fed Chair Powell acknowledged the uncertainty of the policy of U.S. President-elect Donald Trump, the Bank of Korea is likely to reflect this in its decision.' He noted, 'As the won-dollar exchange rate has reached 1,450 won, there may also be concerns about the exchange rate.'