The Bank of Korea meets Friday and is expected to keep rates steady at 2%. However, we note that of the 14 analysts polled by Bloomberg, four are looking for the start of the tightening cycle with a 25 bp hike. We do think tightening will begin in the third quarter, but it will be a very close call and could be either July or August. Minutes from the May 12 BOK meeting showed that three out of five board members wanted to send a strong signal to the markets that interest rates would rise soon. Since May, the economic data has continued to come in strong, while price pressures are rising. CPI rose 2.6% year over year in June and is likely to move into the top of the 2% to 4% target range in the third quarter. Korea policy-makers remain cautious, however, and so we look for only a 25 bp hike in the third quarter followed by another 25 bp in the fourth quarter. The South Korean won (KRW) has done well recently and recovered from second-quarter underperformance, and is one of the top performers in Asia so far in third quarter. We have always thought fundamentals were strong, and so the combination of strong growth and higher interest rates should help KRW outperform further as risk appetite creeps back. Retracement levels to watch for from the June sell off are 1206 and 1197, break of which would target the June low in USD/KRW of 1169.
Malaysia Hikes Rates
Malaysia central bank hiked rates 25 bp to 2.75% as expected, and is the third hike in this tightening cycle. The Malaysian ringgit (MYR) too has done well, and is the second best EM currency so far in 2010. Here too, fundamentals remain strong, and so the combination of strong growth and higher interest rates should also boost MYR. After the hike, the central bank was upbeat about the economy, saying the second quarter saw robust growth. It acknowledged external risks that might moderate growth, but added that strong consumption and investment, augmented by public spending, would keep domestic activity strong. We see rates continuing to rise by about 25 bp per quarter.