Korea Set to Lead Asia’s Rate-Hike Cycle as Lee Flags 2021 Move
The Bank of Korea once again looks set to spearhead Asia’s first interest-rate hikes, after Governor Lee Ju-yeol said policy normalization is in the pipeline this year, triggering a recalibration of market bets.
As pandemic-era stimulus runs the risk of inflating asset bubbles and spurring more volatility in capital flows across the region, several central banks have stressed the need to rein in ultra-loose policy. China has started to curb credit growth, while New Zealand sees a rate hike next year.
Yet, none has come as close to South Korea in signaling an imminent change in rates.
Speaking at a briefing Thursday following the release of a semi-annual report on inflation, Lee said the BOK’s current record low interest rate of 0.5% was “significantly accommodative” and that normalization will start “at an appropriate time this year.”
Korea was also in the vanguard of policy normalization in 2017, though at that time it followed Federal Reserve rate hikes. This time it looks on track to move before the U.S.
“Markets now seem to be looking at a rate hike as early as in October for sure, and they’re weighing if there’s chance for a hike even in August,” said Cho Yong-gu, a fixed-income strategist at Shinyoung Securities Co. “That means the three-year yield may edge up above 1.42%, which is what I had initially forecast as the cap for this year,” he said.
Korea’s short-term bonds dropped on Thursday following the more specific time line from the governor. The central bank has signaled in recent weeks a likely transition to a reining in of pandemic-era stimulus, but the governor had until now refrained from directly mentioning that a move would come this year.
Three-year bond futures dropped as much as 18 ticks to 110.12, while the yield on the same tenure bond advanced 5 basis points to 1.38%, the highest since January 2020. The won climbed as much as 0.3% to 1,133.75 per dollar, in its biggest gain in almost two weeks.
In recent weeks, expectations of rate action have also intensified.
A third of economists in a Bloomberg survey earlier this month said they expected a hike in the final months of this year, bringing forward their projections markedly. The majority still saw an increase by the first quarter of 2022.
“In which month and at what speed the normalization takes place will depend on the spread of Covid variants, the pace at which financial imbalances progress and the momentum of the economic recovery,” Lee said. The governor added one or two rate increases from an emergency level of accommodation shouldn’t be seen as a tightening of monetary conditions.
The country’s reliance on trade makes the economy sensitive to global trends, while volatile capital flows have made Korea more prone to raising rates ahead of others in the past. Heavy borrowing by consumers can also overheat its asset markets easily.
The central bank has four rate decisions left this year, the next one due on July 15. Lee’s current term as governor ends in March 2022.
While bond and currency markets showed signs of tweaked positions rather than wholesale shock, the stock market largely took the prospect of rate hikes in its stride, with the key Kospi Index climbing to an all-time intraday high on Thursday.
A flood of retail interest in niche growth sectors like electric vehicles and biotechnology, as well as positive sentiment toward its export-heavy economy, have boosted Korean stocks. Up about 14% year-to-date, the Kospi is among the top performers in Asia in 2021.
Korea’s economy has performed relatively well throughout the pandemic, shrinking only 1% last year and poised for around 4% expansion in 2021. Inflation also spiked over the BOK’s 2% target in recent months, and the central bank sees growing demand-side pressures as the recovery quickens.
Policy makers have been expressing greater concern over financial stability, as the rally in asset markets was seen unjustified even against the economy’s solid performance. The BOK warned earlier this week that an external shock could bring corrections in asset prices and destabilize the economy.
In contrast to monetary tightening signals, Korea’s policy makers are keen to keep the fiscal spigots open with the government preparing a sixth extra budget of the pandemic. Lee said normalizing monetary policy while the government adds fiscal stimulus isn’t necessarily a policy misalignment.
“There’ll be sectors that experience difficulties as we normalize our monetary policy,” Lee said. “Fiscal policy can offer cover to the self-employed and small business owners.”
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