The Bank of Korea is poised to raise its policy rate by half a percentage point for the first time in the next month to tame inflation that is at a decade-high and shore up the won, according to trader expectations, based on market rates.
South Korea's implied policy rate in six months is around 3.00% as of June 27, according to Bloomberg calculations of money market rates. The central bank may increase rates by 50 basis points once and by 25 basis points three times this year at its four remaining meetings this year, from the current 1.75%.
The central bank said that the BOK has never raised rates by 50 basis points since interest rates became its primary policy tool in 1999. An outsized move would be similar to other central banks, including the Reserve Bank of Australia and the Federal Reserve, which are trying to control runaway inflation with bigger-than-expected hikes. It could help stem losses in the won, which had dropped to a 13 year low.
Shin Earl, fixed-income analyst at SK Securities Co. in Seoul, said a big-step BOK rate hike is likely to become reality due to an expected acceleration in inflation. He expects to have 10 year yields to top 3.95% in the third quarter if the central bank raises rates aggressively.
Expectations of higher rates have caused Korean government bonds to fall, with three-year yields rising to an 11-year high of 3.75% this month.
The fastest growth since August 2008 has occurred 4% from a year ago in May. Finance Minister Choo Kyung-ho said consumer prices may jump more than 6% in June, July and August, according to a KBS interview on Sunday. The last time inflation reached 6% in Korea was in 1998.
In May, producer prices surged by nearly 10%, putting pressure on Korean policy makers to act.
For the local bond market, June-August could be a painful time, with long-term yields possibly climbing above 4%, said Cho yong-gu, a fixed-income strategist at Shinyoung Securities Co.
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