We expect the BOK to cut the base rate again in October, given: 1) the likelihood of continued won strengthening (attributable to global monetary easing); and 2) significant economic downward risk. Under the circumstances (and until the next rate cut), we recommend expanding duration upon yield hikes.

▶BOK leaves base rate frozen for second consecutive month

At the August Monetary Policy Committee (MPC) meeting, members unanimously decided to leave the base rate unchanged. We believe that the Bank of Korea (BOK) needs more time to monitor the effects of: 1) its June base rate cut; and 2) the supplementary budget (proposed). Snowballing household debt was also likely a cause for concern for the central bank. 

▶Additional base rate cut expected in October

The MPC meeting reveals that the BOK remains unsure about the domestic economic recovery, although uncertainties surrounding Brexit have eased. The fact that the central bank talked up the recent won appreciation also indicates its mounting concern towards the strong won trend.

We expect the BOK to cut the base rate again given significant lingering headwinds (even after the June base rate cut) and despite government plans to draw up a supplementary budget in 2H16. Outside of Korea, uncertainties exist towards both Brexit and the upcoming US presidential election; moreover, deflation anxiety has grown again due to oil price declines. On the home front, in addition to existing negatives—the removal of excise tax cuts (at end-June), the enforcement of the Kim Young Ran Act (from end-September), China’s likely imposition of retaliatory measures against Korea (in response to Korea’s decision to deploy THAAD), and massive layoffs (stemming from corporate restructuring)—the strong won trend is likely to weigh on the economy.

That being said, given the need to examine the impact of both the June base rate cut and the execution of the supplementary budget, and further given the sharp growth of household debts (due to persistent low interest rates), the BOK will likely wait longer before delivering another rate cut. And, as the BOK’s monetary decision should also be affected by both Korea 3Q16 GDP growth (feared to weaken) and the results of the September Federal Open Market Committee (FOMC) meeting, it is highly likely that the BOK will not cut the key rate again until October.

▶Patience before next base rate cut; expand duration upon yield hikes

At the August MPC meeting, the BOK did not clearly signal an upcoming base rate cut, an action that may guide investors to keep their bond duration neutral. However, considering the likelihood of further won strengthening (on monetary easing policy stances by major DMs), and further considering the downside risk facing the domestic economy in 2H16, it seems only a matter of time before the BOK cuts the base rate again. Indeed, noting that the central bank still has means for implementing adequate policy measures, the BOK president has left open the possibility of another rate cut. Weighing the above, we advise investors to patiently continue expanding duration upon yield hikes (although bond yields may rise to somewhat demanding levels until the next base rate cut).

Source: NH Investment & Securities