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South Korea’s central bank lifted its repurchase rate on Tuesday by 25bps to 2.5 per cent. A few analysts had been expecting it, and many hadn’t. Either way, the market didn’t seem ready for it – the won gained over 1 per cent against the dollar on the announcement.

In Asia, it seems, currencies wars are off, the war on inflation is back on.

Korean authorities have been walking something of a tightrope recently – having to choose between a rising currency, and rising inflation. They were also careful to avoid attracting yield-hungry investors. The BoK has now bit the bullet, earlier than many were expecting – and chosen to rein in prices.

It’s easy to see why. CPI hit a 20-month high in October, which – at 4.1 percent – is now above the central bank’s target of 2-4 per cent. And the expected flood of money from the Fed’s QE2 programme won’t do much to help matters.

The won also gives Korea some wiggle room. Although it has strengthened this year – especially in the past few months – regional currencies of other exporters – notably the Japanese yen – have risen much further. And in the last month the won has actually dropped 1.6 per cent against the dollar, which perhaps gave the BoK the breathing space needed for the hike. What next? Sharmila Whelan at Bank of America Merrill Lynch is expecting more rises:

We expect YoY headline inflation to start easing at the turn of the year due to base effects. Even so with domestic demand robust inflation risks are on the rise. BoK has shown the appetite to act. Currently we are forecasting to further hike for the rest of this year and three 25bp increases next year. Prospect of more increases next year, are rising, in our view.

So, one rate rise down, more likely to follow.

But what about capital controls? With the G20 now out of the way, and a currency that looks set to benefit from higher rates – it looks like Korea could well take steps to curb hot money soon. Whelan expects Korea to push ahead with the mooted withholding tax on government debt.

Related reading:
Revaluation pressures on emerging markets, FT
Currency warriors should consider India, FT
S Korea considers more capital controls, FT