The Bank of Korea: "Limited Possibility of Significant Inversion Between Short- and Long-Term Interest Rates for the Time Being"

Lee Chang-yong, Governor of the Bank of Korea, is presiding over the regular Monetary Policy Committee meeting held on the 23rd of last month at the Bank of Korea in Jung-gu, Seoul. (Photo by Joint Press Corps)

The Bank of Korea recently explained that the background of the inversion between short-term and long-term interest rates is due to increased expectations of monetary policy easing as inflation and growth forecasts in major countries, including the United States, have slowed. However, it also noted that expectations for monetary policy easing by the U.S. Federal Reserve (Fed) have recently been reversed, making it unlikely that the short- and long-term interest rates will significantly invert again in the short term.

On the 9th, the Bank of Korea analyzed this in its Monetary and Credit Policy Report. Despite the Bank of Korea's successive base rate hikes, long-term market interest rates fell rapidly, leading to an inversion phenomenon in mid-January where government bond yields fell below the base rate. This inversion between short- and long-term interest rates lasted for 21 business days. Compared to past cases, the inversion period was relatively short, but the maximum inversion spread of 39bp (bp = 0.01 percentage points) was relatively large.

Generally, in the bond market, the longer the borrowing period, the higher the interest rate, so the interest rate on short-term bonds with shorter maturities is lower than that of long-term bonds with longer maturities. However, when a recession is expected, long-term bond yields fall, so when short-term interest rates are higher than long-term rates, it is usually interpreted as an increased expectation of an economic downturn.

In major countries as well, since November last year, the spread between short- and long-term interest rates has significantly narrowed, causing inversion phenomena to occur or deepen in most countries. The Bank of Korea analyzed that this was due to a substantial decline in future interest rate expectations as the domestic and international monetary tightening stance continued, leading to slower growth and inflation forecasts.

Additionally, as major countries’ government bond yields fell sharply due to recession concerns and inflation slowdown forecasts, domestic government bond yields quickly synchronized with this trend. Since November last year, the credit bond market, which had been unstable due to incidents such as the 'Legoland incident,' gradually stabilized, reducing the liquidity risk premium in the bond market.

In particular, foreigners intensified downward pressure on interest rates by concentrating large-scale government bond futures purchases at specific times based on expectations of declines in domestic and foreign long-term interest rates.

According to the Bank of Korea, the narrowing and inversion of short- and long-term interest rates since November last year were most influenced by expectations of U.S. monetary easing (27%) and inflation slowdown forecasts (24%). When dividing these factors into domestic and overseas causes, domestic factors accounted for about 55%, and overseas factors about 45%.

The Bank of Korea stated, "It is estimated that the recent decline in expected short-term interest rates contributed significantly, and it is believed that expectations of the base rate were more strongly reflected in government bond yields than those captured by survey methods."

Since the short- and long-term interest rate spread somewhat overreacted to changes in overseas factors and expectations for U.S. Fed monetary easing have recently been reversed, the Bank of Korea explained that the possibility of a significant inversion in the short term is limited.

The Bank of Korea emphasized, "It is necessary to closely monitor market interest rate movements and the resulting changes in fund flows, and to communicate smoothly to ensure that market expectations are formed rationally."

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