Korea likely focus more on macro-prudential measures

The front end of the Korea rates curve appears to be prematurely pricing in a BoK policy rate hike. This is likely due to the central bank's slightly hawkish tone in the June statement on 'greater' attention to financial stability and 'increasing' household debt. 

However, Standard Chartered thinks the BoK and the Korea Financial Supervisory Commission (FSC) are likely to focus more on macro-prudential measures, including lowering loan-to-value (LTV) and debt-to-income (DTI) ratios to address rising household debt, while continuing to maintain an accommodation monetary policy on downside growth risks.

Standard Chartered recommends receiving Korean won (KRW) 2Y, 1Y forward swaps at 1.90%, with a target of 1.50% and a stop-loss of 2.15% for the following reasons: 

• (1) Front-end forward rates, trading c.35bps above the Bank of Korea (BoK) policy rate, appear too high in an environment of prolonged accommodative policy

• (2) downside risks to domestic growth have increased further due to exports contracting in H1-2015 and the Middle East Respiratory Syndrome (MERS) outbreak, while inflation continues to miss the BoK's target band

• (3) the US Fed signalled a cautious stance at its June FOMC meeting, stating that moderate economic conditions "warrant only gradual increases" in the Fed funds target rate.