South Korean bond markets are closely monitoring the Bank of Korea ahead of its monetary policy meeting on the 16th, where the central bank is widely expected to raise its benchmark interest rate for the first time in 3 years 6 months. Market participants are focused on signals regarding the BOK's assessment of economic conditions, inflation, and exchange rates. The heightened attention stems from uncertainty about whether economic risks have sufficiently diminished to stabilize bond markets or whether the current bond market weakness will persist.
BOK Expected to Raise Benchmark Rate to 2.75%
According to bond industry sources on the 15th, the Financial and Monetary Committee meeting scheduled for the 16th is expected to raise the benchmark interest rate by 25bp (1bp=0.01%P) from 2.50% to 2.75%. If implemented, this would mark the first rate increase since January 2023.
BOK Governor Shin Hyun-song has emphasized the need for rate increases on multiple occasions since the May monetary policy committee meeting. At a press conference, he stated that "the path forward is relatively clear whether you look at inflation, growth, exchange rates, or real estate." During a parliamentary report on July 9, he said there is a need to raise rates at an appropriate time considering inflation, growth, and financial stability risks.
Bond Market Awaits BOK Assessment of Economic Uncertainty
The bond market's primary interest lies in the signals the BOK will provide following the rate increase. Market participants want clarity on the BOK's perception of economic conditions, inflation, and exchange rates, and how these factors will be reflected in the future rate path.
A bond manager at a securities firm stated, "Uncertainty regarding upside risks to the economy, inflation, and exchange rates has decreased compared to the May monetary policy committee meeting. How the committee interprets this is important. We are waiting for the BOK's assessment of whether the May dot plot remains appropriate."
The manager added, "If there are mentions of reduced uncertainty, bond yields could confirm this year's upper range, and bonds with maturities under 1 year and credit spreads could gradually stabilize. However, the BOK may maintain a hawkish stance to maximize monetary policy effectiveness."
Expectations for consecutive rate hikes in July and August remain present. Governor Shin's remarks at the May press conference that the bond market does not require stabilization measures and that he would not attach meaning to market reactions contribute to this wariness.
Jung Hyung-joo, a researcher at IBK Investment & Securities, stated, "The BOK's inflation response stance is close to a blitzkrieg (short-term intensive response). After raising rates to 2.75% in July, there is a high possibility of raising the benchmark rate quickly to 3.0% by increasing rates again in August."
US June CPI Data Reduces Federal Reserve Rate Hike Probability
The somewhat reduced possibility of US interest rate increases serves as a factor lowering pressure on the BOK's consecutive July and August rate hikes. As US tightening pressure eases, the BOK gains time to confirm trends in inflation, real estate, and household lending after the July rate increase.
The US June Consumer Price Index (CPI) released overnight fell 0.4% month-over-month, below the market forecast of a 0.1% decline. Core CPI also underperformed expectations.
Following the strong US inflation data, expectations for Federal Reserve rate increases weakened. According to CME Group's FedWatch, the probability of a rate increase at this month's Federal Open Market Committee (FOMC) meeting dropped significantly from 41.7% the day before to 15.5% after the inflation announcement, while the probability of holding rates steady rose from 58.3% to 84.5%.
Ahn Ye-ha, a researcher at Kiwoom Securities, stated, "US June consumer prices show that secondary spillovers from the oil price shock have not yet appeared, easing concerns about US rate increases this year. At least, the justification for early increases by the Fed in July and September has weakened."
Ahn added, "This is a factor weakening the possibility of consecutive BOK rate increases. In the past, periods when the BOK raised rates consecutively coincided with simultaneous rapid Fed tightening and won weakness."
FAQ
What is the Bank of Korea expected to do at its monetary policy meeting on the 16th?
The Bank of Korea is expected to raise its benchmark interest rate by 25 basis points from 2.50% to 2.75% at the Financial and Monetary Committee meeting on the 16th. This would be the first rate increase in 3 years 6 months since January 2023.
How did US June CPI data affect Federal Reserve rate hike expectations?
US June CPI fell 0.4% month-over-month, below the 0.1% decline forecast. Following this data release, the probability of a US rate increase at the July FOMC meeting dropped from 41.7% to 15.5%, while the probability of holding rates steady increased from 58.3% to 84.5% according to CME Group's FedWatch.
What signals are bond markets watching for from the Bank of Korea?
Bond markets are focused on the BOK's assessment of economic uncertainty, including its views on inflation, economic growth, and exchange rates. Market participants want clarity on whether the May dot plot projections remain appropriate and whether economic risks have diminished sufficiently to stabilize bond markets.
