A Back-to-back Rate Hike in May Looks Likely
The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. -- Ed.
Heightened inflation expectations and solid growth outlook to justify BOK’s rate rise in May
A back-to-back rate hike in May looks likely in view of high inflation expectations and short-term fiscal expansion. The growth outlook remains positive, giving the Bank of Korea (BOK) room to raise interest rates to fight inflation. But growing economic uncertainty in China is feared to weigh down on Korean exports. We believe now is the time to lower expectations for a GDP growth of 3% this year. The BOK is unlikely to adjust down its growth forecast in the upcoming revision of economic outlook, given high expectations for recovery of domestic consumption and investment in the second quarter. With GDP growth still expected at mid/high-2% levels, the central bank should go ahead with another rate increase in May.
Positive changes to take time to come into effect; keep an eye on issues at home and abroad in May
Forecasts of slower growth in China pose a risk to Korea’s growth prospects. China accounts for 25% of total exports and 20% of intermediate goods exports as of 2019. Korean exporters will be hit hard if China’s economy slows down, and overall growth should decelerate. With his comments on the need to balance growth and inflation, the new BOK Governor Rhee Chang-yong has helped to ease concerns that the US benchmark rate may rise above that of Korea within this year. However, these positive changes will take time to come into effect. The Monetary Policy Board meeting will provide a glimpse into the BOK’s stance in monetary tightening. We therefore need to keep an eye on issues at home and abroad in May.
For this month, we suggest a yield band of 2.80-3.05% for 3Y KTBs and 3.05-3.35% for 10Y KTBs. The 3Y-10Y yield spread should move within 25-30bp. The BOK will likely raise the base rate at the May meeting in efforts to rein in inflation. We will need to wait for economic indicators for April and May to tell whether economic growth will decrease. Some believe key KTB yields have arrived at their peak levels, but it seems still too early for follow-through buying. We recommend investors to wait and check on internal/external issues until the upcoming meeting.