South Korean bond market participants are raising terminal rate expectations amid growing forecasts for back-to-back interest rate hikes in August. Market consensus had anticipated the base rate reaching around 3.5% by mid-next year through gradual quarterly increases. Following last week's GDP growth rate announcement, expectations shifted toward faster rate hikes potentially elevating the terminal rate beyond initial projections. The concern centers not only on immediate funding cost increases but on the possibility that accelerated tightening pace could push the cycle's final rate higher than the 3.5% baseline forecast.
Market Raises Terminal Rate Projections Following GDP Data
According to bond market participants on the 27th, the prevailing market view had been that the base rate would rise to around 3.5% by mid-next year, with gradual increases occurring once per quarter during this monetary tightening cycle. However, following last week's GDP growth rate announcement, expectations for back-to-back rate hikes have spread through the market. Market participants noted that while immediate funding rate increases of 25 basis points are a concern, the greater worry is that the overall pace of rate increases within the cycle could accelerate, potentially pushing the terminal rate higher than previously expected. If back-to-back hikes do not result in a higher final rate, the market impact would be limited, but if the number of rate increases expands, market weakness could deepen.
JP Morgan Elevates Terminal Rate Forecast to 3.75%
JP Morgan, which raised its terminal rate forecast to 3.75% after this month's Monetary Policy Board meeting, stated after the GDP growth rate announcement that "we still judge there are additional upside risks related to terminal rate discussions." Park Seok-gil, JP Morgan economist, noted that second-quarter GDP came in slightly stronger than expected and that growth momentum would strengthen further through 2027, leading to substantial upward revisions in next year's growth forecast. The firm raised this year's growth forecast from 3.7% to 3.8% and next year's from 2.7% to 3.3%. Park emphasized that "while we want to stress that the composition of growth remains unbalanced, it is still premature to place a strict upper limit on the terminal rate." He noted that improvements in terms of trade could affect both real purchasing power and price dynamics with a lag, and that the firm's recent reassessment points to the possibility of an upward shift in the potential growth rate trend.
Oil Price and Exchange Rate Risks Cited by Market Participants
The possibility of renewed escalation in U.S.-Iran tensions and significant oil price increases was identified as a factor that could raise the terminal rate. A bond dealer at a bank stated, "Rather than back-to-back hikes, if international oil prices rise above $100 and stay there for several months, the terminal rate could go up." The dealer explained, "In terms of direction, there is a possibility that rates could go higher. Ultimately, exchange rates and oil prices are important, but oil prices are more critical because we must also consider global interest rate linkages." While the dollar-won exchange rate has fallen significantly to around 1,460 won, which would offset inflationary shocks from rising oil prices, if global interest rates rise due to international oil prices, South Korea cannot remain free from additional tightening.
Citi Maintains 3.5% Terminal Rate Despite August Hike Expectation
Citi projected that despite back-to-back rate hikes in August, the terminal rate would remain unchanged at 3.5%. The firm anticipated that preemptive increases would allow for a faster conclusion to the rate hike cycle. Previously, Citi had viewed next year's April as the final rate hike timing, but moved this forward by two months to February. Some forecasts suggest that after back-to-back increases in August, the central bank would maintain rates for an extended period. Choi Ji-wook, researcher at Korea Investment & Securities, pointed out that "private employment and regular salary growth rates remain weak, and it is difficult to see them rising in the second half, so while core inflation will maintain the mid-2% range, the possibility of further increases is low." Considering that stock market corrections could dampen semiconductor export momentum by year-end, and if oil prices decline as consensus expects, core inflation could peak at year-end, real interest rates would continue rising even with base rate maintenance, making further aggressive increases difficult.
BOK Governor Shin Comments on Monetary Policy Trajectory
Bank of Korea Governor Shin Hyun-song stated at the July 16 Monetary Policy Board press conference that "core inflation does not draw its own parabola but changes its trajectory depending on how monetary policy responds. So if we use monetary policy well, it will not remain above the target level for a long time." He added, "Because the pace must account for the entire monetary policy path and policy must be used accordingly, this is not like riding a bicycle but like operating a large oil tanker."
FAQ
What is the current market expectation for South Korea's terminal interest rate?
Market participants initially expected the base rate to reach around 3.5% by mid-next year through gradual quarterly increases. Following stronger-than-expected second-quarter GDP data, some forecasts have risen, with JP Morgan elevating its terminal rate projection to 3.75%.
Why did JP Morgan raise South Korea's growth forecast?
JP Morgan raised this year's growth forecast from 3.7% to 3.8% and next year's from 2.7% to 3.3% after second-quarter GDP came in slightly stronger than expected. The firm cited strengthening growth momentum through 2027 and potential upward shifts in the potential growth rate trend.
What external factors could push South Korea's terminal rate higher?
Market participants identified international oil prices rising above $100 and remaining elevated for several months as a key risk factor. Renewed U.S.-Iran tensions and global interest rate linkages were cited as reasons oil price increases could necessitate additional monetary tightening despite the dollar-won exchange rate falling to around 1,460 won.
