By Choonsik Yoo

SEOUL (Reuters) – South Korea’s central bank got ahead of the tightening curve last year but now faces pressure to go faster and further as the won’s weakening fuels inflation and that the US Federal Reserve is taking a broad approach to raising rates.

The Bank of Korea, the first major Asian central bank to move away from crisis-era parameters last August, faces a narrowing policy rate differential with the United States. If domestic rates tend to fall relative to US rates, capital outflows could increase pressure on the currency.

Investment banks and economists are beginning to change their minds on how quickly the BOK will raise rates, with some forecasting the key rate to rise to as much as 2.50% by year-end, versus 1.50% currently.

Governor Rhee Chang-yong, seen as less hawkish than his predecessor, will chair his first policy meeting this month when factors such as the Russian-Ukrainian war make it harder to predict when inflation will eventually subside.

“Inflation has repeatedly exceeded expectations, meaning that South Korea’s policy rate has actually come down in real terms despite recent hikes,” said Seok Gil Park, an economist at JPMorgan Chase Bank. The bank raised its rate forecast to 2.50% by the end of the year, from 2.00% previously.

The won has fallen nearly 7% so far this year to around 1,273 to the dollar after losing nearly 9% last year. It looks set to breach the psychologically significant 1,300 won barrier for the first time since the 2008/09 global financial crisis.

The won weakened due to foreign sales of domestic stocks and a deterioration in the trade balance, among other factors, which bodes ill for inflation. South Korea is heavily dependent on imports of energy, foodstuffs and industrial components.

According to official data, import prices in won have risen by 30% or more annually for each of the past six months, helping to push inflation up to more than a decade in April from less than 2.5% six months earlier.

Along with inflation, central bank policymakers also need to be concerned about the risk of capital flight.

US and South Korean policy rates https://fingfx.thomsonreuters.com/gfx/mkt/myvmnylxbpr/won1.png

NEGATIVE RATE GAP CONCERNS

South Korea’s policy rate premium over the midpoint of the US federal funds rate has narrowed to 62.5 basis points now, from 112.5 points at the end of January.

The midpoint of the US target range is expected to reach 2.125% by the end of the year, according to a Reuters survey, while the BOK base rate is expected to reach 2.00%.

“Policymakers are watching the situation closely from a financial stability perspective, from a capital flow perspective,” said Chung Sung-tai, senior economist at Samsung Securities, noting that the won was down despite the rhetoric. repeated interventions.

The BOK and the Fed will meet five times each for the rest of this year, but the latter is widely expected to raise its key rate by wider margins than the former.

The won’s fall had often raised concerns among investors about the health of Asia’s fourth-largest economy, which narrowly avoided bankruptcy in the late 1990s and suffered a capital outflow in 2008-09.

Minutes of the BOK’s April 14 meeting showed a small majority of board members calling for vigilance amid the won’s decline and the risk of foreign capital outflows.

South Korean won weakens https://fingfx.thomsonreuters.com/gfx/mkt/movanoaddpa/won2.png

South Korea said its economic fundamentals have improved significantly in recent years, but former Bank of Korea governor Kim Choong-soo told Reuters capital flows remained a major concern for policymakers .

South Korea’s two major stock markets have recorded foreign net sales in all but two of the past 11 quarters, with net sales in the 11 quarters amounting to 63.05 trillion won ($49.5 billion). ). Foreign investors are also selling this quarter to date.

“Can the credit spread alone fuel an outflow? Yes, and that’s why we have to be very careful of the (negative) credit spread that occurs,” said Kim, who has was governor from 2010 to 2014.

($1 = 1,274.0100 won)

(Editing by Jacqueline Wong)