Doubt surrounds central bank’s growth forecast

Korea’s 10-year bonds have the smallest yield premium over shorter-dated debt since July, as the world-beating won threatens the economy’s recovery.

The spread to three-year notes narrowed to 51.5 basis points on May 29, from as wide as 79 on Jan. 8. Mirae Asset Global Investments and KB Asset Management predict it will reach as low as 40 basis points in 2014 as a resurgent won curbs exports, while mourning for the worst ferry accident in four decades dampens consumer spending.

HSBC Holdings and BlackRock doubt the Bank of Korea’s (BOK) 4 percent growth forecast for this year can be achieved as the won appreciated the most against the dollar and the yen in the past year among 31 major currencies. Economists expect the BOK to keep its benchmark rate unchanged on June 12, and have delayed expectations of an increase to the first quarter of 2015, according to separate surveys by Bloomberg.

“The yield curve can flatten further as the economy will grow slower than the central bank’s forecast and rate-increase bets have been pushed back,” said Moon Dong-hoon, head of fixed income at KB Asset which oversees 33 trillion won ($32 billion). “The won’s strength can hurt the profitability of major companies, and there isn’t much pressure on inflation.”

The won has appreciated 11 percent against the dollar and 15 percent versus the yen in 12 months. Korea’s exports unexpectedly contracted 0.9 percent in May from a year earlier, the most since September, official data show. A slowdown in China, which accounts for about 25 percent of overseas sales, is also clouding prospects.

Finance Minister Hyun Oh-seok said on June 5 that government efforts to boost growth will continue as consumption has yet to recover after the Sewol ferry sank April 16, killing at least 292 people. The ministry said in a monthly report today that the government will closely monitor risks at home and abroad, including the weak yen.

“There aren’t many positive factors for Korea’s economy at the moment, with a weaker yen and slower China growth making it hard for exports to grow,” said Choi Jin-young, head of the fixed-income management team at Mirae Asset which oversees 51 trillion won. The possibility of a rate cut remains open if the won’s strength hurts exports, he said.

Consumer prices rose 1.7 percent in May from a year earlier, the most since October 2012. The BOK on April 10 cut its inflation projection for this year to 2.1 percent from 2.3 percent, while raising its gross domestic product growth projection from 3.8 percent. State think tank, the Korea Development Institute, last month lowered its 2014 inflation estimate to 1.6 percent from 2 percent.

The BOK’s 4 percent growth forecast “looks increasingly difficult” to achieve, said Andre de Silva, Hong Kong-based head of Asia-Pacific rates research for HSBC.

BlackRock expects Korea’s GDP to increase about 3.5 percent this year, “with risks to the downside,” and predicts the benchmark rate will stay unchanged in 2014, Christian Carrillo, director of Asian fixed income in Singapore, said.

HSBC’s de Silva predicts Korea’s 10-year rate will fall to 3.2 percent in the next two months, a level last seen in June 2013, and expects the strong won to impact export and the economy with a lag of about 12 months.

The central bank has held its benchmark seven-day repurchase rate unchanged at 2.5 percent since a cut in May 2013.

Korea’s economy expanded 3.9 percent in the first quarter from a year earlier, the fastest pace in three years, prompting BOK Governor Lee Ju-yeol to say in May that the rate is supportive of growth and the next step will be an increase.

“The implied path that’s been directed by the central bank is unlikely to materialize,” de Silva said. “The long end of yields should come down rather than rise.”

Bloomberg