Korean rate cuts seen delayed as funds predict calm before storm

[SINGAPORE] South Korean policy makers' economic optimism - seen as misguided by some observers - will probably delay interest-rate cuts.

Swaps traders have pared the chances of Bank of Korea lowering the benchmark rate to 64 per cent within the next three months, from 88 per cent in mid-February, as concern over the global economic outlook eased. The Korean economy is recovering from a slump earlier this year, although financial markets are still volatile, finance minister Yoo Il Ho said last week, setting the tone for the BOK's next meeting on April 19.

"With policy makers recently saying the economy is improving, a cut in April has become less likely," said Moon Dong Hoon, the Seoul-based head of fixed income at KB Asset Management Co, which oversees about 50 trillion won (S$58 billion).

"If you look at data, the economy isn't improving but just isn't deteriorating further," he said, adding that he sees two rate cuts this year.

This month's meeting will be the last before four new nominees take their posts at the BOK, with Goldman Sachs Group Inc economists Goohoon Kwon and Irene Choi speculating the new board will need to recalibrate its message before any cut. While exports slumped for a 15th month in March, they fell less than expected and February's industrial production showed a surprise increase, according to data released last week.

"The current data will give comfort for BOK to keep the current rate," said Chong Hoon Park, head of Korean research at Standard Chartered Plc in Seoul.

"BOK will take a wait-and-see strategy for its monetary policy."

Won-denominated sovereign bonds advanced for a fourth month in March and have returned 2.6 per cent this year, according to a Bloomberg index. The benchmark three-yearbond yield has dropped 21 basis points in 2016 to 1.45 per cent, five basis points less than the BOK's 1.5 per cent record-low policy rate.

The central bank has held its benchmark since July on concern a cut would trigger more outflows amid a slowdown in China and tightening monetary policy in the US. Overseas funds pumped a net US$4.7 billion into Korean stocks and bonds in March, after pulling US$2.6 billion in the first two months of the year, exchange data show.

China Worry

12 of 23 economists surveyed by Bloomberg see the central bank leaving its benchmark rate unchanged through the end of the year. Six see a cut to 1.25 per cent, four predict a level of one per cent and one forecasts 0.75 per cent.

The economy expanded 3.1 per cent in the fourth quarter, the most since the three months through Sept 2014. Exports fell 8.2 per cent in March, less than the median estimate for a 10.9 per cent drop in a Bloomberg survey.

The won's 8.2 per cent jump in March, the most in Asia, and the weak export performance in the first quarter, mean the central bank will probably cut by 25 basis points in April, said Tim Condon, head of Asia research at ING Groep NV in Singapore. While the sharp appreciation will curb imported inflation, a reduction in May is "more likely" than April, Goldman Sachs said in a research note.

Inflation will average 0.62 per cent through 2025, according to the break-even rate, a measure of price increases bond traders expect over the life of inflation-linked notes due 2025. That's up from an estimate of 0.37 per cent in mid-January. Consumer prices rose one per cent in March from a year earlier.

The yield on 10-year Korean bonds has dropped 28 basis points this year to 1.79 per cent and reached a record low of 1.77 per cent on Monday. A yield of 1.9 per cent would be a good level to buy at, said Jun Kato, a senior fund manager in Tokyo at Shinkin Asset Management, which oversees US$6.8 billion.

"The Bank of Korea is likely to stay on the sidelines to see the situation for a while," said Mr Kato.

"China remains a concern and if economic conditions worsen, it's possible to see one more rate cut around June to September."

BLOOMBERG