Following last night’s employment news, the South Korean won strengthened by about 1.2% against the US dollar on speculation that the Bank of Korea may be poised to increase interest rates tonight.  Although unemployment remains at a 3-year low, the realistic potential for such a move remains slim to none at this point – which is likely to hurt the KRW in the short term.

For most of the year, Bank of Korea officials have kept to the idea of steady interest rates, in light of rising consumer prices and robust industrial output by Asia’s fourth largest economy.  For the record, consumer prices remain at records above 4% annually.  Industrial output, supported by a strengthened export sector, is churning ahead at a 4.8% annualized pace.  The sentiment has been founded on the belief that short term demand upticks in commodities and raw materials have led to higher inflation in the region.  And, central bankers remain intent on seeing these temporary price anomalies dissipate.

In line with this sentiment, market economists are already seeing signs of declining prices surfacing.  According to the latest report released by Statistics Korea, consumer prices fell by 0.2% to 4.3% from a high of 4.5%.  A big reason why prices fell were agricultural product prices – a key proponent of why prices were higher in the first place.  With inflation now seemingly on the way down, South Korean central bankers will likely not have much when it comes to justifying a 25 basis point rate hike.

And then there’s Europe.

In speeches and interviews made throughout the year, with the most notably recent being at this year’s Jackson Hole Summit, Bank of Korea Governor Kim Choongsoo has expressed his concern over the European Financial Crisis.  With Europe’s troubles far reaching and the potential fallout systemic, this concern is similar to other global central banks – fearing the worst may damage individual economic expansion.  Given that the crisis is still looming, markets can expect that the Bank of Korea will continue to monitor the situation until a realistic resolution in passed and implemented before making any pivotal monetary decisions.

But, it’s not just the European region, but the Asian region as well that’s of concern.  Bank of Korea policymakers are going to take into consideration what is happening in their immediate area as well – in particular, with economies like China, Japan and Taiwan.  All three countries are major exporting countries (South Korean competitors) and are leading indicators to potential weakness in the region’s overall expansion.  Incidentally, markets have already begun pricing in a slowdown as Japanese and Chinese output data has begun showing weakness – not to mention surprise rate cuts in Indonesia over the last 24 hours.  So, given the tepid results in the region, it’s likely that the BOK will remain on the defensive rather than the offensive when it comes short term monetary policy.

A no-decision by Bank of Korea officials is likely to spark a short term correction in the USDKRW exchange rate, with traders eyeing the 1174.00 resistance for any profit taking on a surge higher.  But, there’s always the possibility of further momentum lower in the currency pair should central bankers hint at a potential shift in monetary sentiment.  For this to happen though, the USDKRW needs to break below the current support of 1164.00.