Korea Linker Sale Smallest This Year as Inflation Forecasts Cut

South Korea sold the least inflation-linked bonds since November after the government and central bank lowered their consumer-price gain forecasts.

The finance ministry sold 34 billion won ($33 million) of the notes at a monthly auction yesterday, compared with 86 billion won in July, according to a statement today on its website. The government revised its 2014 inflation projection to 1.8 percent on July 24 from 2.3 percent, two weeks after the Bank of Korea cut its estimate to 1.9 percent from 2.1 percent. The central bank reduced its policy rate by 25 basis points to 2.25 percent on Aug. 14.

“Expectations for consumer-price gains are subdued at the moment, lessening the attractiveness of inflation bonds,” said Yoon Yeo Sam, a Seoul-based fixed-income analyst at Daewoo Securities Co., one of 21 primary dealers that participate in government auctions. “Linkers are also facing a correction, just like other South Korea bonds, as bets for an additional rate cut recede.”

The yield on the inflation linked bonds due June 2023 rose four basis points, or 0.04 percentage point, to 1.55 percent as of 1:50 p.m. in Seoul, according to Korea Exchange Inc. prices. That’s the highest level since July 14. The yield for the 3.5 percent fixed-rate sovereign securities due March 2024 advanced three basis points to 3.13 percent.

Break-Even Rate

The BOK said in its biannual report on consumer-price trends last month that downside risks to inflation are greater than upside risks. The finance ministry unveiled a 11.7 trillion won fiscal-spending plan on July 24 after cutting its economic growth estimate for this year to 3.7 percent from 3.9 percent, citing weak domestic spending.

South Korea first sold linkers in 2007. The securities pay interest twice a year and the coupon and the final principal redemption amount are tied to the headline inflation rate.

The break-even rate, which measures the difference in yields of inflation-linked bonds and fixed-rate debt, dropped 13 basis points this month to 1.65 percent yesterday, data compiled by Bloomberg show. Consumer prices rose 1.6 percent in July from a year earlier, compared with 1.7 percent in May and June, the highest since October 2012.

The won has rallied 4.8 percent in the past six months, the most among 11 regional peers tracked by Bloomberg. South Korea’s local-currency government debt returned 5.06 percent this year, while linkers handed investors a 7.13 percent gain, Bank of America Merrill Lynch indexes show.

“The outperformance of linkers versus nominal bonds will weaken from the fourth quarter, as was seen in the past cases when yields were on an upward track,” Lee Mi Seon, a Seoul-based fixed-income analyst at Hana Daetoo Securities Co., wrote in a report today. “With inflation projected to stay moderate, investors should lower their expectations for linkers’ returns.”

To contact the reporter on this story: Jiyeun Lee in Seoul at jlee1029@bloomberg.net

To contact the editors responsible for this story: James Regan at jregan19@bloomberg.net Andrew Janes, Robin Ganguly

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