April 29 (Bloomberg) -- South Korea’s swaps market is pricing in bets for the first increase in benchmark borrowing costs since 2011 as central bank Governor Lee Ju Yeol raises his guard against inflation.
The one-year interest-rate swap, the fixed payment needed to receive the floating rate on three-month certificates of deposit, rose to 2.71 percent on April 23, the highest since Jan. 3. The Bank of Korea, which has held its seven-day repurchase rate at 2.50 percent since May, will lift it to 2.75 percent in the fourth quarter, according to the median estimate in a Bloomberg survey of 27 analysts.
Asia’s fourth-largest economy expanded at the fastest pace in three years last quarter as recoveries from the U.S. to Europe boosted exports. Governor Lee said April 10 the benchmark rate, currently the lowest since December 2010 and below the 3.27 percent average for the past decade, may rise if price pressures build. Inflation will quicken to 1.5 percent this month, the fastest since August, according to Bloomberg survey before data due May 1.
“South Korea’s interest-rate cycle needs to be normalized,” Arthur Lau, who helps oversee $71.4 billion as the Hong Kong-based head of Asia ex-Japan fixed income at PineBridge Investments Asia Ltd., said in an April 24 telephone interview. “If the economy starts to pick up, it’s highly likely the benchmark rate will point upward. Inflation is very subdued at the moment, and the earliest rate increase will come in the fourth quarter.”
South Korea’s gross domestic product growth accelerated for a fourth straight quarter, increasing 3.9 percent in the three months ended March 31 from a year earlier, an official report showed April 24. The central bank raised its 2014 growth projection to 4 percent from 3.8 percent on April 10, saying the global economic recovery will support demand for exports and domestic demand will rise as companies boost investment.
The BOK cut its 2014 inflation projection to 2.1 percent from 2.3 percent on April 10. Lee said the same day that recent low figures were due to “temporary supply factors.” Speaking in Washington two days later, he said surprise interest-rate actions aren’t desirable and predictability helps businesses make decisions months in advance, Yonhap News reported. Lee became central bank governor on April 1.
Investors can benefit from betting on further increases in the swap rate, according to Wee-Khoon Chong, Nomura Holdings Inc.’s Singapore-based head of rates strategy for Asia ex-Japan.
The 12-month swap contracts starting in a year may rise to 3.10 percent by the end of this year from the current 2.91 percent as the bank expects the BOK to raise its benchmark rate in December, Chong said in an April 24 e-mail interview.
Fourteen of the 27 economists surveyed by Bloomberg expect South Korea to raise borrowing costs at least once this year. ING Groep NV is the only bank to forecast a cut of 25 basis points, 0.25 percentage point, while the rest expect no change.
The rate increases will be gradual rather than steep, according to Lau at PineBridge. “We have a neutral position on Korean government bonds and have no plan to reduce holdings in the next few months,” he said.
The yield on three-year government bonds has climbed five basis points from this year’s low on March 14 to 2.88 percent today, data compiled by Bloomberg show. Daewoo Securities Co. predicts it will reach 3.1 percent this quarter as the economy improves.
The won has strengthened 3.3 percent in April to 1,030.57 per dollar at the close in Seoul, the best performance among 31 major currencies tracked by Bloomberg. It reached 1,030.49 earlier today, the strongest since August 2008. Global funds increased their holdings of local bonds by $914 million this month as of April 25, figures from the financial regulator show. They bought $2.9 billion more South Korean equities than they sold, exchange data compiled by Bloomberg show.
“The new BOK governor is seen as hawkish and his signals on benchmark rate changes point upward,” said Kim Kihyun, who oversees 16 trillion won ($15.5 billion) as head of fixed income at Woori Asset Management in Seoul, said in an April 25 telephone interview. He expects borrowing costs to remain unchanged this year, with increases starting in 2015.
ING is sticking with its forecast for a rate cut in 2014 as the lack of additional government spending will result in South Korea’s full year economic growth falling short of the central bank’s revised 4 percent estimate, Tim Condon, Singapore-based head of research at the Dutch financial services company, wrote in an April 23 report. ING had said on April 11 it plans to review its rate call.
President Park Geun Hye introduced a 17.3 trillion won extra budget in May last year, with no additional fiscal stimulus planned this year.
“Fixed investment was the big domestic consumption contributor last year,” Condon wrote. “Absent the fiscal boost, we expect fixed investment’s contribution to growth to decline” and the BOK to “downgrade the forecast and cut the benchmark rate by another 25 basis points to 2.25 percent.”
Industrial output for March probably increased 3.7 percent from a year earlier, following February’s 4.3 percent gain, while export growth in April likely accelerated to 5.5 percent from 5.1 percent in March, according to separate surveys by Bloomberg News before official reports due this week.
Thirty-day volatility for South Korea’s three-year government bonds dropped to 6.97 percent as of yesterday, the lowest since 2007, according to data compiled by Bloomberg.
“Low volatility in the bond market indicates traders have refrained from making investment decisions so far, but this could change once the economic trend becomes clearer,” said Yoon Yeo Sam, a Seoul-based analyst at Daewoo Securities Co. “A hawkish governor is making a drop in bond yields difficult, and we advise investors to prepare for increases.”
To contact the reporter on this story: Jiyeun Lee in Seoul at email@example.com