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Swaps market signals BOK interest rate hike

South Korea’s swaps market is pricing in bets for the first increase in benchmark borrowing costs since 2011 as central bank Gov. Lee Ju-yeol raises his guard against inflation.

The one-year interest-rate swap, the fixed payment needed to receive the floating rate on three-month certificates of deposit, rose to 2.71 percent on April 23, the highest since Jan. 3.

The Bank of Korea, which has held its seven-day repurchase rate at 2.50 percent since May, will lift it to 2.75 percent in the fourth quarter, according to the median estimate in a Bloomberg survey of 27 analysts.

Asia’s fourth-largest economy expanded at the fastest pace in three years last quarter as recoveries from the U.S. to Europe boosted exports. Lee said April 10 the benchmark rate, currently the lowest since December 2010 and below the 3.27 percent average for the past decade, may rise if price pressures build. Inflation will quicken to 1.5 percent this month, the fastest since August, according to Bloomberg survey before data due May 1.

The country’s interest-rate cycle needs to be normalized, Arthur Lau, who helps oversee $71.4 billion as the Hong Kong-based head of Asia ex-Japan fixed income at PineBridge Investments Asia Ltd., said in an April 24 telephone interview. If the economy starts to pick up, it is highly likely the benchmark rate will point upward. Inflation is very subdued at the moment, and the earliest rate increase will come in the fourth quarter.

South Korea’s gross domestic product growth accelerated for a fourth straight quarter, increasing 3.9 percent in the three months ended March 31 from a year earlier, an official report showed April 24. The central bank raised its 2014 growth projection to 4 percent from 3.8 percent on April 10, saying the global economic recovery will support demand for exports and domestic demand will rise as companies boost investment. 

The BOK cut its 2014 inflation projection to 2.1 percent from 2.3 percent on April 10. Lee said the same day that recent low figures were due to temporary supply factors. Speaking in Washington two days later, he said surprise interest-rate actions aren’t desirable and predictability helps businesses make decisions months in advance, Yonhap News reported.

Lee became central bank governor on April 1.

Investors can benefit from betting on further increases in the swap rate, according to Nomura Holdings.

The 12-month swap contracts starting in a year may rise to 3.10 percent by the end of this year from the current 2.91 percent as the bank expects the BOK to raise its benchmark rate in December, Nomura Holdings said.

Fourteen of the 27 economists surveyed by Bloomberg expect South Korea to raise borrowing costs at least once this year. ING Groep NV is the only bank to forecast a cut of 25 basis points, 0.25 percentage point, while the rest expect no change.

The rate increases will be gradual rather than steep, according to Lau at PineBridge. He have a neutral position on Korean government bonds and have no plan to reduce holdings in the next few months,he said. (Bloomberg)