▲ Bank of Korea
As the likelihood of the Bank of Korea (BOK) raising its base interest rate at this month's Monetary Policy Board meeting grows, the gap between long-term interest rates in South Korea and the United States has narrowed to its smallest level in about three years.
According to the BOK Economic Statistics System today (July 15), the yield on South Korea's 10-year government bonds stood at 4.18% last month, 0.29 percentage points (p) lower than that of the United States (4.47%).
This marks the narrowest gap since July 2023 (-0.22%p), a period of two years and 11 months.
Compared to the BOK's base rate of 2.50%, which is 1.25%p lower than the upper bound of the U.S. federal funds rate (3.50%–3.75%), the gap is approximately one-fifth of the base rate difference.
The 10-year yields of the two nations began to diverge after the base rates inverted in July 2022. The U.S. yield surpassed Korea's starting in December of that year, and the gap steadily widened to 1.81%p in January of last year.
Since the second half of last year, the gap began to shrink, reaching -0.72%p in January and -0.52%p in February of this year.
Last month, the gap narrowed by an additional 0.11%p from the previous month (-0.4%p).
Market observers believe it is highly likely that the BOK will enter a full-scale interest rate hike cycle starting with the Monetary Policy Board meeting on July 16, with the possibility of at least one additional hike within the year.
In contrast, while expectations for U.S. interest rate cuts have virtually vanished due to inflation concerns, forecasts regarding whether the Federal Reserve will raise or freeze rates for the remainder of the year remain divided.
According to a recent report by the BOK's New York office, seven out of 10 major investment banks predicted that the Fed would freeze interest rates for the rest of the year.
Bank of America and Deutsche Bank projected three and two rate hikes, respectively, while only Citi (one hike) forecasted a rate cut.
In a survey conducted in May, five out of 10 investment banks predicted rate cuts within the year, but that number dropped to one over the past two months.
Expectations for Fed rate hikes within the year, as reflected in the U.S. futures market, stood at 1.2 hikes as of July 6, up from 0.1 hikes in May.
While the outlook for monetary tightening intensity differs between the two countries, the significant improvement in South Korea's growth prospects, driven by strong semiconductor exports, also appears to have influenced the narrowing of the long-term interest rate gap.
The 10-year long-term government bond yield reflects not only monetary policy outlooks but also economic fundamentals such as growth and inflation.
Generally, as economic prospects improve, demand for long-term government bonds—considered safe assets—decreases, and long-term interest rates rise due to increased inflation expectations.
In its World Economic Outlook released in July, the International Monetary Fund (IMF) projected South Korea's real gross domestic product (GDP) growth for this year at 2.6%, an upward revision of 0.7%p from its April forecast (1.9%).
This is the highest level among the advanced economy group (South Korea, the U.S., Japan, the U.K., Germany, France, Australia, Canada, Italy, Spain, and the Netherlands), including the U.S. (2.3%).
The growth forecast for next year (2.5%) was also the highest among advanced nations.
In its economic growth strategy for the second half of the year announced yesterday, the government projected South Korea's GDP growth for this year at 3.0%.
If the government's projection holds, it would mark the highest growth rate in five years since 2021 (4.7%).
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