Korea Rate-Cut Bets Rise as Park Seeks to Kick-Start Economy

South Korean three-year bond yields that have held below the policy rate for a month are prompting speculation the central bank will cut borrowing costs as soon as next week as President Park Geun Hye seeks to revive growth.

The yield on the 2.75 percent government notes due December 2015 was 2.63 percent today, the lowest for a benchmark three-year security in data going back to August 2000 and less than Bank of Korea’s seven-day repurchase rate of 2.75 percent. It stayed below the benchmark rate for more than three months before the central bank last reduced borrowing costs in October. The monetary authority will review policy on March 14.

Park pledged in her Feb. 25 inauguration speech to revitalize the economy at a time when Korean exports, which account for more than half of gross domestic product, are under threat from the Japanese yen’s 24 percent plunge against the won in the past six months. Deutsche Bank AG said on Feb. 8 that it expected a 25 basis point cut in March and Goldman Sachs Group Inc. said yesterday there would be a reduction in the first half, most likely in April.

“We are long on bonds,” said Moon Dong Hoon, who oversees 12 trillion won ($11 billion) as managing director of fixed income at KB Asset Management Co. in Seoul, adding that he has increased holdings of five-year debt. “Freezing interest rates will be out of sync with policies to be rolled out by the new finance chief.”

Forecast Cut

The Korean economy expanded 1.5 percent last quarter from a year ago, matching the slowest pace in three years, official figures show. Industrial production unexpectedly fell in January from December as output of chips and electronic components dropped, Statistics Korea said on Feb. 28. Exports declined 8.6 percent last month, according to a March 1 report.

The Bank of Korea lowered its forecast for economic growth in 2013 to 2.8 percent on Jan. 11 from an October estimate of 3.2 percent. The economy will expand 3.8 percent in 2014, and inflation will accelerate to 2.8 percent from a projected 2.5 percent this year, according to the monetary authority.

Governor Kim Choong Soo held the benchmark seven-day repo rate steady on Feb. 14. For a second month, the decision wasn’t unanimous. An improved global outlook increases the odds of South Korea exceeding this year’s growth target, Kim said in a Feb. 19 interview, damping expectations for a rate cut.

“Data aren’t strong enough to call it an economic recovery,” KB Asset’s Moon said. “Prices remain subdued, the won is strong, foreign capital continues to flow in, and the new government wants to boost growth. The foreign exchange holds the key to the BOK’s action.”

Supplementary Budget

A supplementary budget may be announced by Park’s administration in March to bolster growth, Frankfurt-based Deutsche Bank said in its Feb. 8 report. Slower expansion warrants monetary and fiscal stimulus, needed to offset the negative impact of a weaker yen, the bank’s Hong Kong-based economist Juliana Lee wrote. An extra budget of about 10 trillion won will bolster gross domestic product growth by 0.4 percentage point, according to the report.

“The talk of a supplementary budget is a double-edged sword to the bond market as it means an increase in debt sales but also shows the fragile status of the economy,” KB Asset’s Moon said.

The yield on the 2.75 percent government bonds due September 2017 fell 15 basis points in the past month to an all-time low of 2.73 percent today, according to data compiled by Bloomberg. The rate on the 3.75 percent notes due June 2022 fell one basis point to 2.94 percent today, matching a record-low of 2.93 percent earlier. The yield premium investors demand to hold 10-year debt over three-year securities was 31 basis points yesterday after reaching a seven-month high of 39 basis points on Jan. 4, data compiled by Bloomberg show.

‘Control Tower’

“Market players are probably uncomfortable with current yield levels,” said Cha Sang Yong, head of the fixed-income department at Kyobo Axa Investment Managers Co. in Seoul. “Expectations for a rate cut will not die down. If the BOK keeps rates on hold in March, people would think then it will come along in April.” Cha said he has been buying 10-year bonds because yields on the three- and five-year notes are below the policy rate.

Newly-appointed Finance Minister Hyun Oh Seok, 62, also serves as deputy prime minister for the economy, a move that Barclays Plc said was intended to elevate the finance ministry’s status as an economic “control tower.” Hyun has a Ph.D. in economics from the University of Pennsylvania and worked for the World Bank and South Korea’s finance ministry before becoming head of the nation’s top research body in 2009, according to Korea Development Institute’s website.

Strengthening Won

Global investors have pumped a net $353 million into South Korean local-currency bonds so far this this year following inflows of $6.4 billion in 2012, according to fund researcher EPFR Global. Consumer prices increased 1.4 percent in February from a year earlier, the fourth month in a row they have advanced less than 2 percent, official data show.

The won strengthened 4.5 percent against the dollar over the past six months to 1,087.04 as of 1:28 p.m. in Seoul, according to data compiled by Bloomberg yesterday. The Korean currency will appreciate 4.5 percent to 1,040 by year-end, according to the median estimate of 27 analysts surveyed by Bloomberg.

The KDI said in its semi-annual economic report on Nov. 25 that monetary policy should be used more actively to help stabilize the economy as inflationary pressures remain subdued and as expectations of a stronger won draw overseas capital.

Japanese Stimulus

The plunging yen has eroded the competitiveness of exporters such as Samsung Electronics Co., which said in January that currency gains could trim its operating profit by 3 trillion won this year. Kia Motors Corp. reported a 51 percent slump in operating profit the same month and said it expects a difficult year.

The Bank of Japan may add more stimulus as early as April, with prospective governor Haruhiko Kuroda saying yesterday in Tokyo the central bank will do whatever is needed to end 15 years of deflation should he be confirmed as its head. The monetary authority hasn’t bought enough assets and should consider buying large amounts of longer-term bonds, he said.

The yen, which lost 16 percent against the dollar in the last six months, will weaken a further 2.1 percent by the end of the year, according to the median estimate of 57 economists surveyed by Bloomberg.

Household Debt

Korea’s one-year interest-rate swap has fallen 11 basis points this year to 2.68 percent. Five of 14 economists surveyed by Bloomberg expect the benchmark rate to be cut to 2.5 percent by the end of this quarter, with the rest seeing no change.

“The Korean economy is still export-driven and can’t shake off the impact of the yen’s weakness,” said Kwon Young Sun, a Hong Kong-based economist at Nomura International Ltd. “However, unless the currency market turns notably unfavorable, we don’t forecast the central bank will cut rates, which could trigger a further buildup of household debt” that rose to a record high of 959.4 trillion won last quarter, he said.

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