The world economy is racing toward a global currency war following a flurry of benchmark rate cuts or hinted cuts by developed and developing countries to counter a prolonged economic sluggishness.

Caught between a weaker yen ― which has breached 100 yen to the U.S. dollar for the first time since 2009 ― and government pressure, the Bank of Korea’s key base rate cut to 2.50 percent for May joined a list of other central bankers trying to avert further downturns through weaker currencies.

Europe and Australia made rate cuts, ending their passive stance on falling spending and commodity prices, while other economies such as New Zealand and Taiwan have not ruled out the possibility.

Korea’s exporters, prone to external conditions, may soon be hit hard by competitive Japanese manufacturers buoyed by a weaker yen, which has helped Japan’s electronics and entertainment giant Sony back into the black and boosted Toyota’s profit.

The BOK’s rate cut was surprising, given that it previously resisted state pressure to “mix” a looser monetary policy with the government’s fiscal stimulus that included an extra budget. But it may have been an inevitable move under a slew of factors such as Korea’s long period of low growth, Japan’s weakening yen and a global movement toward rate cuts.

The Korean central bank claimed that it did not take a weak yen into account for its rate decision. Instead, it said the government’s 17 trillion won supplementary budget, the biggest since the Asian financial crisis of the late 1990s, was the main reason as a means to increase the effect of the fiscal stimulus.

“The central bank seemed to have no choice but to listen to the government’s call for a rate cut, as the appreciation of the won would affect Korean exports,” said June Park, an analyst at Meritz Securities.

But the currency trend certainly was on financial policymakers’ radar. Indeed, one of the few remaining tools to counter other countries’ currency depreciation is devaluing one’s money. A rate cut could accomplish this, as low borrowing costs would, theoretically, expand money supply or credit, lowering the value of the currency.

Also, a cut will shorten the interest rate gap with developed countries that are printing and pumping money into their markets to shore up their economies, and slow capital inflows and the won’s rise.

However, given Korea’s recovery projections in the latter half of this year that could draw capital to the country, a weaker won through a lower rate could have a limited effect.

“The central bank’s rate cut could slow capital inflow of the so-called yen carry trade, but the won-dollar exchange could fall on recovery projections in the U.S. and Korea toward the year’s end,” said Lee Sang-jae, an analyst at Hyundai Securities.

By Park Hyong-ki (hkp@heraldcorp.com)