Fixed income strategy: BOK’s clear policy guidance eases uncertainty
The author is a bond strategist from Shinhan Investment Corp. He can be contacted at [email protected] — Ed.
Focus on fighting inflation despite slowing growth risks
The Monetary Policy Board (MPB) of the Bank of Korea (BOK) unanimously decided to raise the policy rate by 50bp to 2.25% at the policy meeting in July. Downside risks have increased at home and abroad, but fears of entrenched inflation have grown amid growing upward pressure on prices across the board. The BOK made its first-ever 50bp rate hike based on the judgment that it could pay a higher price later if it failed to get inflation under control now.
Consumer price inflation has risen more than the BOK had expected and may continue to climb. Import prices of agricultural, livestock and fishing products have been rising since March. The depreciation of KRW amid continued supply chain disruptions is pushing prices higher. Administered prices are expected to further contribute to CPI growth in July with the government’s decision to increase utility bills. National gasoline prices are down about 4% from the end of June thanks to fuel tax cuts in July and are expected to fall further. However, we expect consumer price inflation to continue on its upward trajectory this month, with lower gasoline prices being offset by higher utility costs and higher prices for agricultural products, oil and gas. farming and fishing.
BOK Governor Rhee Chang-yong said inflation should gradually stabilize at lower levels after peaking at the end of the 3rd quarter or the beginning of the 4th quarter, and that it would be desirable to increase the base rate in increments of 25 basis points as long as inflation remains on the expected lines. His remarks helped ease concerns about back-to-back sharp rate hikes in August and falling inflation expectations. We expect another 25 basis point increase in August.
BOK’s clear policy guidance eases uncertainty over future rate moves
As Rhee’s comments in the press conference following the meeting show, the central bank communicated its position more clearly than in the past. Rhee said inflation should gradually stabilize at lower levels after remaining high for a few months, and that it would be desirable to raise the base rate in 25 basis point increments as long as inflation remains on expected lines. These comments ruled out the possibility of another 50 basis point hike in August and showed the BOK’s commitment to fighting inflation by hinting at more moderate rate hikes in upcoming meetings. The base rate is raised to 2.25%, but market expectations now point to more than 2.50%. The BOK communicated with the public, much like the US Fed does with its forward guidance.
Rhee said the base rate of 2.25% approximates the lower end of a theoretical range of neutral rates, although specific numbers were not given. The phrase “adjust the degree of accommodation” was dropped from the July monetary policy decision statement, suggesting a shift in policy stance away from monetary easing. Rhee also said it was indeed reasonable for the market to expect the BOK to raise the rate to 2.75-3.00% by the end of the year, and clarified that he will have to see some Signs of high inflation taking hold at over 3%.
The BOK’s views of the base rate near the lower end of the neutral range and market expectations for 2.75-3.00% will help ease uncertainty about future rate moves. They dispel fears of successive rate hikes and at the same time stabilize expected inflation. With the base rate approaching the lower end of the neutral range, we need to consider the impact of future rate hikes on growth. If inflation exceeds expectations, steeper rate hikes may be required. The likelihood is low given the recent declines in crude oil and petroleum product prices. The market’s year-end base rate forecast is likely to be between 2.50 and 2.75%. We maintain our forecast of 2.75% with two increases of 25 bps in August and October.
Bond yields near peak; rebound in long-term yields to create a buying opportunity
The BOK clarified its policy stance at the July meeting, easing interest rate uncertainties. Bond yields continue their downtrend, although the central bank made its first-ever rate hike of 50 basis points and hinted at another hike in August. We believe that the KTB 3-year yield will not recover from its previous high of 3.75% reached in mid-June, as the base rate is not expected to rise above 3% within the year. The BOK is moving away from monetary easing to raising interest rates in its effort to contain inflation. As a result, concerns about slowing growth are likely to intensify, limiting further upside in long-term yields. We therefore recommend taking a buy approach if long-term yields rebound after the MPB meeting.