South Korean government bond yields and interest rate swaps bounced to their highest in more than two weeks, bracing for a possible rate hike as a monthly monetary policy board meeting drew closer. Analysts suspect the Bank of Korea will either step up its warning of inflation risks at its August 12 rate-setting meeting or raise interest rates for the second time in a row.
Interest rate swaps extended their advance in afternoon trade, led by shorter tenors. One-year interest rate swaps gained 3.5 basis points to 3.16 percent, the highest close since July 20, widening the spread with steady three-month certificate of deposit rates, which are used as a benchmark for floating rates.
Adding to the caution was the finance ministry's sale of 1.2 trillion won ($1.0 billion) worth of five-year treasury bonds on Monday. Three-year treasury futures dropped 0.10 points to 110.85 on the back of foreign and local banks' selling. A fixed-income trader at a foreign bank said investors had been uncomfortable with the yield levels of the past few days, which were not seen as having priced in another rate increase.
The Bank of Korea unexpectedly lifted interest rates by 25 basis points last month from a record low. "Investors just wanted to prepare for the possibility of a rate hike next week as the monetary policy board meeting was approaching, rather than the odds looking stronger for interest rate rises," he said.