South Korea will closely monitor the financial market as market volatility could increase following the Federal Reserve's signal of an earlier-than-expected rate hike, a senior government official said Thursday.

After freezing its key rate at near zero at a policy meeting, the Fed signaled an earlier-than-expected rate increase in 2023 as US inflation is rising amid an economic recovery. The US central bank also hinted it began discussing when to taper bond-buying programs.

Bearing the Fed's surprise results, South Korea's key stock index, the KOSPI, was trading 17.17 points, or 0.52 percent, lower at 3,261.51 as of 11:22 a.m. The Korean currency was trading at 1,127.90 won per US dollar, sharply down 10.70 won from the previous session.

First Vice Finance Minister Lee Eog-weon said the country has strong economic fundamentals and policy room to cope with potential market volatility, citing its FX reserves and an extended currency swap line with the US

"The government has sufficient policy room to cope with (potential market volatility) in times of an emergency situation," Lee said at a government meeting on macroeconomic situations.

The official said the government will not lower its guard against financial market situations as growing inflation concerns and possible rollbacks of easy monetary policy by major economies could sharply increase market volatility.

The Bank of Korea (BOK), the country's central bank, said it plans to take steps to stabilize the financial market if needed.

The country has beefed up its capability to secure FX liquidity in a bid to brace for unexpected market routs.

South Korea's FX reserves rose to a record high of $456.4 billion in May, up $4.15 billion from the previous month, according to central bank data.

The BOK and the Fed agreed Wednesday to extend their $60 billion currency swap agreement by another three months through Dec. 31.

The two nations opened the swap line in March 2020 and have extended it twice in a bid to help ease potential FX liquidity shortage amid the pandemic. (Yonhap)