Even if interest rate hikes stop, returning to a low-interest rate environment is difficult

Korea Capital Market Institute Report on 'Assessment and Implications of Rising Government Bond Yields'
Expectations for Decline in Government Bond Yields Require Base Rate Cut and Inflation Stabilization

[Asia Economy Reporter Hwang Yoon-joo] A recent analysis by the Korea Capital Market Institute (KCMI) suggests that the recent rise in government bond yields is largely influenced by trend factors such as potential growth rates, rather than being a temporary phenomenon caused by monetary policy.

Baek In-seok, a senior researcher at KCMI, explained in a recent report titled "Assessment and Implications of the Recent Rise in Government Bond Yields" that "while the recent increase in yields reflects cyclical factors (monetary policy) such as the base interest rate hikes, the rise in trend yields has had a greater impact."

The recent rise in yields has drawn attention because it represents the longest sustained upward trend since 2000 and has significantly surpassed the average low-interest rates that began after the 2008 global financial crisis. In fact, the 3-year Treasury yield bottomed at 0.815% on May 25, 2020, following the outbreak of COVID-19, and peaked at 4.548% on September 26 of this year.

According to data analyzed by the Bank of Korea and KCMI, the government bond yields were 0.85% in Q2 2020 and 4.19% in Q3 2022, marking an increase of 3.34 percentage points. During the same period, the trend yields were estimated at 1.27% and 3.35%, respectively, with an increase of 2.08 percentage points.

The trend component of nominal yields (which do not account for inflation) is shaped by potential growth rates and trend inflation rates. Cyclical components can be influenced by various factors, particularly changes in the base interest rate (monetary policy cycle).

Researcher Baek explained, "Of the 3.34 percentage point increase in government bond yields from Q2 2020 to Q3 2022, 2.08 percentage points are attributable to the rise in trend yields, while the cyclical factors contributed 1.26 percentage points." This means that although cyclical factors reflecting base rate hikes were involved in the recent yield increase, the rise in trend yields had a larger effect.

Meanwhile, the rise in trend yields was found to be more influenced by trend inflation rates than by potential growth rates. Of the 2.08 percentage point increase in trend yields, an estimated 1.94 percentage points were due to the increase in trend inflation. Baek noted, "The implication is that even if base rate hikes cease, a significant decline in cyclical yield factors is unlikely unless the base rate is lowered," adding, "Cyclical factors tend to diminish when the base rate is cut."

Secondly, Baek pointed out that for the decline of trend yields that have driven the rise in yields, a prompt and stable reduction in inflation rates is essential. He stated, "Although accumulated tightening policies may lower inflation, there is considerable uncertainty about returning to a low-inflation environment," and assessed that "structural factors such as deglobalization, declining labor force, and accelerated climate change responses may prevent a return to a low-inflation regime." He further emphasized, "Considering that domestic economic agents are accustomed to a low-interest rate environment, it is necessary to prepare for economic and financial market difficulties associated with the possibility of sustained high interest rates."

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