Lee Ju-yeol "The pace of widening Korea's short- and long-term interest rate gap was faster than expected"

"Adjustment of Monetary Stabilization Bond Issuance Possible if Bond Market Supply-Demand Imbalance Deepens"

[Image source=Yonhap News]

[Asia Economy Reporter Kim Eun-byeol] The Bank of Korea recently reduced the issuance scale of Monetary Stabilization Bonds to prevent a sharp rise in market interest rates. Governor Lee Ju-yeol stated that if the supply-demand imbalance in the bond market worsens, the issuance scale of Monetary Stabilization Bonds can be adjusted accordingly. He also acknowledged the recent widening of the long-term and short-term interest rate spread in the bond market, noting that the speed of this spread expansion in South Korea was rapid.

On the 24th, Governor Lee, in a written Q&A with reporters on major issues, said, "Monetary Stabilization Bonds are the most important liquidity adjustment tool, so it is difficult to significantly reduce their utilization," but added, "the future issuance scale will be determined based on the required liquidity adjustment scale (excess reserve absorption requirement) as before."

He continued, "If the need to respond to increased mid- to short-term interest rate volatility or worsening supply-demand imbalance in the bond market grows, the issuance scale can be flexibly adjusted in the short term as was done this time."

Monetary Stabilization Bonds are short-term securities issued by the Bank of Korea to financial institutions or the general public to regulate the money supply. When the Bank wants to reduce the money supply, it issues and sells these bonds in the open market; conversely, when money supply is needed, it repurchases or redeems the bonds before maturity to adjust the money supply.

On the 17th, the Bank of Korea halved the bidding scale for 2-year Monetary Stabilization Bonds from 2.2 trillion won to 1.1 trillion won, and on the 22nd, it halved the 1-year bond bidding scale from 600 billion won to 300 billion won. Reducing the issuance scale of Monetary Stabilization Bonds decreases the supply in the bond market, causing bond prices to rise (and bond yields to fall). This move is understood as a market stabilization measure in response to increased volatility in the government bond market, where the 10-year Korean Treasury bond yield recently exceeded 2% due to a sharp rise in U.S. Treasury yields. Given the recent high volatility in the bond market, adjusting the issuance scale according to market conditions can boost investor sentiment and mitigate interest rate volatility.

*Source: Bank of Korea

Governor Lee also acknowledged the recent widening of the long-term and short-term interest rate spread in the bond market. He said, "Typically, during economic recovery periods, long-term interest rates rise in anticipation of improving fundamentals, leading to a wider long-term and short-term interest rate spread, a phenomenon commonly seen in major countries including the U.S. However, since March, the widening of the domestic long-term and short-term interest rate spread has been influenced not only by economic recovery expectations but also significantly by external factors such as rising U.S. Treasury yields and supply-demand conditions in the Korean Treasury bond market, causing the spread to widen faster than expected." He explained that the rapid expansion of the long-term and short-term interest rate spread compared to major countries is being closely monitored.

The Bank of Korea conducts simple purchases of Korean Treasury bonds if market interest rates rise excessively or volatility increases. This year, with an increase in government bond issuance for the supplementary budget, the Bank has already announced it may purchase more than 7 trillion won in Korean Treasury bonds. Governor Lee stated, "The scale of simple Korean Treasury bond purchases depends on how smoothly liquidity can be absorbed through the issuance of Monetary Stabilization Bonds, sale of repurchase agreements (RPs), and deposits in the Monetary Stabilization Account," adding, "Simple Korean Treasury bond purchases can be conducted without particular difficulties in terms of liquidity absorption for the time being."

However, simple Korean Treasury bond purchases are market stabilization measures to respond to increased market interest rate volatility and differ in purpose and operation from quantitative easing (QE), which increases liquidity supply or aims to guide market interest rates to a specific level, or from Operation Twist. Governor Lee explained, "Operation Twist is a policy where the central bank adjusts the maturity of government bonds it holds from short-term to long-term. This differs from the Bank of Korea’s approach, which absorbs liquidity supplied through Korean Treasury bond purchases by issuing Monetary Stabilization Bonds as liabilities," adding, "It would be difficult to refer to simple Korean Treasury bond purchases as Operation Twist."

This content was produced with the assistance of AI translation services.