Rebound in Long-term Yields to Create Buying Opportunity
The author is a fixed income strategist of Shinhan Investment Corp. He can be reached at jk.ahn@shinhan.com. -- Ed.
Focus placed on fighting inflation despite downside risks to growth
The Monetary Policy Board (MPB) of the Bank of Korea (BOK) made a unanimous decision to raise the base rate by 50bp to 2.25% at the policy meeting in July. Economic downside risks have increased at home and abroad, but fears of entrenched inflation have grown amid mounting upward pressure on prices across the board. The BOK delivered its first-ever 50bp rate hike based on the judgement that it may pay a bigger price later if it fails to rein in inflation now.
Consumer price inflation has risen higher than the BOK anticipated and may climb further down the road. Import prices of agricultural, livestock, and fisheries products have been on an uptrend since March. The KRW depreciation amid continuing supply chain disruptions is sending prices higher. Administered prices are expected to make bigger contribution to CPI growth in July with the government’s decision to raise utility bills. Gasoline prices nationwide are down by about 4% compared to end-June thanks to fuel tax cuts in July and are projected to fall further. However, we believe consumer price inflation will continue its upward trajectory this month, with gasoline price declines offset by rising utility costs and prices of agricultural, livestock, and fisheries products.
The BOK governor Rhee Chang-yong said that inflation should gradually stabilize at lower levels after peaking in late 3Q or early 4Q, and that it would be desirable to raise the base rate by increments of 25bp as long as inflation stays on expected lines. His remarks helped to ease concerns over back-to-back big-step rate hikes in August and lower inflation expectations. We project another 25bp increase in August.
BOK’s clear policy stance eases uncertainty over future rate moves
As seen in Rhee’s comments at the post-meeting press conference, the central bank communicated its stance more clearly than in the past. Rhee said that inflation should gradually stabilize at lower levels after remaining high for some months, and that it would be desirable to raise the base rate by increments of 25bp as long as inflation stays on expected lines. These comments dismissed the possibility of another 50bp hike in August and showed the BOK’s commitment to fighting inflation by hinting at more moderate rate increases at upcoming meetings. The base rate is raised to 2.25%, but market expectations now point to over 2.50%. The BOK communicated with the public, just like the US Fed does with its forward guidance.
Rhee said the base rate of 2.25% nears the lower end of a theoretical neutral rate range, though specific numbers were not given. The phrase “adjust the degree of accommodation” was deleted from the July Monetary Policy Decision statement, suggesting a shift in policy focus away from monetary easing. Rhee also said that it was indeed reasonable for the market to forecast the BOK to raise the rate to 2.75-3.00% by the end of the year, and clarified it will need to see signs of high inflation becoming entrenched for over 3%.
The BOK’s views on the base rate nearing the lower end of the neutral range and market expectations for 2.75-3.00% will help to remove uncertainty over future rate moves. They dispel concerns of back-to-back big-step rate hikes, and at the same time stabilize expected inflation. With the base rate nearing the lower end of the neutral range, we need to consider the impact of future rate hikes on growth. If inflation rises beyond expectations, steeper rate hikes may be needed. The probability is low given recent declines in crude oil and oil product prices. The market’s year-end base rate forecast will likely come in the 2.50-2.75% range. We maintain our forecast of 2.75% with two 25bp hikes in August and October.
Bond yields close to peak; rebound in long-term yields to create buying opportunity
The BOK made its policy stance clear at the July meeting, removing uncertainties over interest rates. Bond yields continue on a downtrend, although the central bank delivered its first-ever 50bp rate hike and hinted at another increase in August. We believe the 3Y KTB yield will not rally again to its previous high of 3.75% reached in mid-June, as the base rate is unlikely to rise above 3% within the year. The BOK is moving away from monetary easing toward raising interest rates in its efforts to rein in inflation. Concerns over the slowdown in growth should intensify as a result, limiting further upside in long-term yields. We thus recommend taking a buying approach if long-term yields rebound following the MPB meeting.