BOK Moves to Prop Up Bonds

Calling the recent increase in interest rates "a psychological market reaction", the central bank said Friday it will provide up to 5.6 trillion won ($4.2 billion) in liquidity to prop up the bond market.

Bank of Korea Governor Chon Chol-hwan said the central bank would not issue new repurchase agreements to counter the release of 4.6 trillion won in liquidity into the economy cause by agreements which come due Friday. "The market continues to be conservative in fund operations, and we believe a temporary imbalance in supply and demand can lead to undesirable overshooting of bond yield targets," he said. The bank will also retire 500 billion won to 1 trillion won of the 8.6 trillion won in monetary stabilization bonds maturing before the end of the month, Mr. Chon said. "The portion arriving due in May will also be subject to retirement if circumstances warrant." The bonds are used in the central bank's open market operations. A total of 5.3 trillion won in such bonds are due to mature next month.

The market reacted lukewarmly to the announcement, but bond yields ended the day down after climbing for 9 consecutive days. The yield on the benchmark three year government bond was down 8 basis points to 6.85 percent. The average yield on three year AA-minus corporate bonds fell 6 basis points to 8.11 percent.

The central bank said the recent string of rate increases can be attributed to the fall in expected returns and surging demand for liquidity due to the estimated 7.3 trillion won in business tax payments concentrated at the end of April. Money market fund balances have been declining rapidly, the central bank said, giving rise to expectations that fund managers will unload bonds from their portfolio. Fund balances fell by nearly 4 trillion won in April with a net decline in bond portfolios of nearly 3 trillion won. "The psychological factor will be settle considerably in May, and the selloff of money market funds will moderate," Mr. Chon said.

by Kim Young-sae