The South Korean won could stay under pressure in the next three months over worries of escalating tension with the North and Europe’s deepening financial crisis, but should resume appreciation after that.
The Korean won weakened considerably in May, falling almost 8% against the US dollar and traded at W1205 against the greenback at 3.00pm Hong Kong time on June 8.
This risk aversion was brought on by concerns about the Eurozone and also potential slower growth in China.
“Europe is very important market for Korea, both directly and indirectly,” said Brian Jackson, senior strategist for emerging markets at RBC Capital Markets in Hong Kong, in an interview with asiamoney.com. “As demand falls due to slower growth and austerity measures, it would hurt Asian exports to the continent.
“There’s also the potential that it’s going to drive up financing cost more broadly. Problems in Europe could increase risk premiums across the globe. We haven’t seen too much evidence of it so far but it’s something we need to keep a close eye on over the next three to four months.”
Worries about North Korea also added to the pressure. Seoul’s northern neighbour has been accused of torpedoing a South Korean warship in March. The international community has threatened sanctions, with the North responding with threats of military confrontation.
These factors suggest weak sentiment will weigh on the Korean won for the next few months. Jackson forecasts that the won will trade at W1,202 against the greenback at the end of June.
Continued weakness in the currency potentially offers investors a good entry point, with RBC forecasting that appreciation will resume in the next six- to 12-months.
“We believe that the sell-off in May was overdone with respect to fundamentals. Assuming that North-South tensions eventually ease in the months ahead, this should allow the Korean won supportive factors to regain investors’ attention later this year,” said Jackson in a report published yesterday.
RBC forecasts that the won will fall to W1,125 at the end of the September, W1,050 at the end of the year and W1,000 at the end of 2011.
The won is likely to benefit from solid economic data – the economy grew by 2.1% quarter-on-quarter in the first three months of the year – and a strong external position. Foreign exchange reserves came to US$272 billion at the end of March.
Another positive effect on the won’s longer-term value is the likelihood of rate hikes. Jackson believes that the Bank of Korea will start raising interest rates in the second half from the record low of 2%, with a 25 basis point (bp) increase in the third quarter and another 50bp in the final quarter.
“If we take it to 275bp, it’s still well below what it was before the Lehman collapse and still pretty accommodative…which is supportive for growth as well,” he said.
“It should be moderately positive for the won. We think they’re going to go quicker and sooner than the [US Federal Reserve] so that’s going to increase the interest rate differential in favour of Korea and that should promote a boost to the won.”