Inflation-adjusted bond yields, real interest rates fall below zero
By Cho Jin-seo
Both real interest rates at banks and actual yields on treasuries have fallen into “relative” negative territory due to the prolonged low rate policy, spawning fears that ample liquidity in the market will look for risky assets offering higher returns, leading to a bubble in asset prices.
The real interest rate — which takes inflation into account — has already fallen below zero, as major banks now only offer around 3 percent interest on 1-year deposits while inflation is hovering at 3.6 percent.
The inflation-adjusted yield on 3-year sovereign bonds — a market benchmark — also dropped to minus 0.55 percent in September from 1.13 percent in August.
The negative real interest rate and bond yield means that investments in bonds and bank deposits actually decrease in value over time. The bank rates and yields fell rapidly as the Bank of Korea (BOK) decided not to raise its key rate of 2.25 percent last Thursday.
A low interest rate is considered a tool for economic stimulus, while it can also spur inflation as a side effect. Analysts say that the central bank is more interested in stimulating the economy and is less worried about consumer price rises.
“It seems that the central bank has decided that the high inflation in September was a short-term event. (With the decision to hold the base rate still) it highlighted the risk of slow growth in the future,” said Park Tae-keun at Hanwha Securities in a report Friday.
Bank interest rates on savings accounts were as high as 6 to 7 percent at the height of the financial crisis in the second half of 2008. Most banks now offer below 3.5 percent on one-year savings accounts. The Korea Development Bank pays its customers only 2.93 percent in interest on the same product.
The situation is similar in the bond market. The inflation-adjusted yield on 3-year bonds was 2.49 percent in July 2009. Now, it is below zero, which is only the third time in Korea’s economic history.
“As expected returns on bank deposits and bonds have fallen sharply, it is now difficult to increase portfolios with fixed-income assets,” Daewoo Securities said in a report.
The remaining question is where the money will go now. Warnings are everywhere that liquidity is flowing from fixed-income assets to more speculative assets, such as stocks, real estate and commodities such as gold.
According to Woori Investment & Securities, short-term liquidity in the financial market has increased by 110 trillion won since August 2008 as a result of the low-interest rate policy of the central bank. Since this summer, banks have been losing about 3 trillion won in savings account deposits every month, while deposits in stock-trading accounts have increased by a similar amount.
Even the sluggish real estate market is possibly being maintained artificially by a liquidity bubble. Mortgages grew by some 7 trillion between July and September, despite a slow decline in both the price index and the number of contracts signed.
Despite a flood of worries they have with the low interest rate policy, the BOK and its governor Kim Choong-soo have been cautious. A growing concern is that a rate hike may further spur capital inflow from overseas into Korea.
As the United States, Japan and most other rich countries have even lower interest rates than Korea, a rate increase can attract more money from foreign investors, creating even bigger bubbles in the equity and commodities market, analysts worry.
Beside the bubble risk, some think the real reason for the central bank’s holding down of the rate is the foreign exchange rate.
“The ‘currency war’ and quantitative easing have put appreciatory pressure on the Korean won. We believe this was the critical factor in discouraging the central bank from raising the rate,” said Lhee Jeong-beom of Korea Investment & Securities.
It is a hint that the government is using the BOK’s monetary policy to keep the won’s value down in an international competition over currency devaluation, in order to help exporters, which in turn indicates the central bank is more interested in economic growth, rather than in controlling inflation.
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