Fixed income strategy
The author is an analyst for Shinhan Securities. He can be reached at jk.ahn@shinhan.com -- Ed.
BOK in a bind, unable to raise or cut rates
Consumer price inflation slowed down to 2.7% YoY in June, falling to 2% levels for the first time since September 2021. Contribution to CPI growth by category came in at 0.95%p for goods, dropping under 1% for the first time since February 2021, and 1.75%p for services, still high but the lowest recorded in past 14 months. The slower increase in prices of goods was the main driver behind the slowdown in inflation, with the downturn in prices of services yet to pick up pace.
Rising prices of personal services, dining out in particular, were the main contributors to CPI growth from services in June. We have yet to see a notable downturn in services prices with demand remaining solid despite high price levels on the back of post- pandemic recovery and inbound traffic growth. After remaining below the baseline over the past year amid aggressive monetary tightening by the central bank, Korea's Composite Consumer Sentiment Index (CCSI) rose above 100 in June. Due to unabated consumption, core CPI could remain above the trajectory previously forecast in May unless aggregate demand starts to decline in the near term. We therefore believe the Bank of Korea (BOK) will be open to the possibility of a rate hike to 3.75% at the upcoming Monetary Policy Board (MPB) meeting in July.
Nevertheless, we find it encouraging that inflation excluding administered prices is now slowing down. Contribution of administered prices to CPI growth reached 1.19%p in June, staying in the 1%p range since October 2022. Inflation may continue its downward trend to meet the BOK’s target, if administered prices are kept at current levels by limiting utility rate hikes. Although open to the possibility, the central bank is thus unlikely proceed on an actual rate hike to 3.75% in July. The CPI data for June reaffirmed that the BOK is in a bind, unable to raise or lower rates for the time being.
KTB yields unlikely to drop under 3.50% ahead of July MPB meeting
The gap between the 3-month CD rate nine months from now and the 3-month CD rate points to a 0.04%p rate increase going forward. The gap turned positive from mid-June, indicating reduced market expectations for a rate cut within the remainder of the year. With the latest CPI data seen unlikely to affect monetary policy decisions, demand for bonds has remained weak even after the confirmation of June consumer price trends.
Arbitrage opportunities for foreign investors turned negative from the latter half of June. As a result, we expect to see limited buying activity from foreign investors, in addition to sluggish demand from domestic institutional investors in the near term. With the next rate-setting meeting expected to end on a slightly hawkish note, 3Y KTB yields should see downside support around the base rate of 3.50% ahead of the July MPB meeting. Dissipating concerns over a supplementary budget and deficit-financing KTBs should keep the 3Y/10Y spread in the 0bp range and yield curves on a flattening path.