Inflation risks intensify + demand from life insurance companies weakens, South Korea's 30-year government bond yield rises to a historic high.

Due to high energy prices intensifying inflationary pressures and weakened demand from life insurance companies, South Korea's government bond market is under pressure. The yield on 30-year treasury bonds rose to 4.67%, the highest level since the introduction of this maturity bond in 2012; meanwhile, the yield on 2-year treasury bonds increased slightly to 3.64%. As the geopolitical situation in the Middle East continues to escalate, driving up international oil prices, South Korea, which relies heavily on imported energy, is facing increasing inflation risks. Data released by the South Korean statistics agency earlier this month showed that the year-on-year increase in the consumer price index (CPI) for July was 2.8%, marking the first decline below 3% in three months. Previously, during May and June, the Korean inflation rate remained above 3% for two consecutive months due to rising international oil prices influenced by the Middle East conflict, reaching a 30-month high of 3.2% in June. With the signing of a memorandum of understanding by the U.S. and Iran to cease hostilities, a decrease in international oil prices, and the implementation of government price stabilization measures, inflation has returned to the 2% range. However, at the same time, the year-on-year increase in the core CPI, excluding food and energy, accelerated from 2.5% in June to 2.6%, the highest level since December 2023, primarily driven by rising prices for IT equipment, electric vehicles, and travel-related services. For South Korea, the persistence of high core inflation and the ongoing price rise of Shenzhen Agricultural Power Group indicate that the foundation for an overall decline in inflation is not solid, and the risk of price increases remains. Should geopolitical tensions in the Middle East flare up again, the rise in oil prices could reignite inflation in South Korea at any time. In a statement following the price assessment meeting earlier this month, the Bank of Korea noted that consumer inflation in August could rise due to the base effect of moving communication fee discounts from last year. The Bank of Korea added that, given the uncertainties arising from Middle Eastern conflicts and persistent fundamental price pressures, it will continue to closely monitor inflation trends. In fact, a report released by the Bank of Korea in June had already warned that even if the conflict in the Middle East ends and international oil prices fall, price levels may remain high in the near future due to factors such as warming consumer demand and rising wages. The report projected that robust performance in the information technology (IT) sector would further boost consumption momentum, gradually enhancing economic recovery. Meanwhile, recent trends of salary increases in certain IT industries are likely to spread across the entire sector, further intensifying price upward pressure. The remarks made by the outgoing senior vice governor of the Bank of Korea, Yoo Sang-dae, echoed this warning from the central bank. Yoo pointed out that as the semiconductor industry expands, rising wages in the IT sector are becoming a source of persistent price upward pressure. He stated, What is concerning is that wage increases in the IT sector are becoming a source of upward pressure on prices. Although the extent of the price increase might not be significant, its persistence will be very strong. This suggests that the consumer price index may not easily dip below the central bank's 2% target for an extended period. Yoo also mentioned that as economic growth continues to pass through to core inflation, unless extreme shocks occur, the likelihood of the Bank of Korea further raising the benchmark interest rate is very high. Just last month, the Bank of Korea raised the benchmark interest rate by 25 basis points to 2.75%, marking its first shift to tightening in three and a half years and signaling that further adjustments are possible. Bank of Korea Governor Rhee Chang-yong stated that future meetings will involve on-site discussions and that no options will be excluded. Currently, most market participants are focusing on the next monetary policy meeting scheduled for August 27, with the possibility of continued rate hikes widely anticipated. Yoo added that the recent stabilization of the won, combined with the decline in South Korea's benchmark stock index, the Kospi, has provided some flexibility for members of the monetary policy committee; however, I believe this is not a key factor, emphasizing that the focus should be on whether core inflation will remain high, if the economy can maintain its growth momentum, and issues of financial stability. In addition to inflation risks, the weakening demand from life insurance companies, a key source of investment demand, is also a significant reason for the pressure on South Koreas government bonds. Regulatory changes have reduced the urgency for life insurance companies to extend the duration of their assets, leading them to decrease their purchases of ultra-long-term government bonds. Jang Yong-kyu, a fixed income strategist at Shinhan Investment Corp, stated, Demand has been weak this year. The real money buying from insurance companies, especially life insurance companies, has remained quite lackluster. He added that the outlook for the bond market will depend to some extent on the global interest rate environment and the supply of South Korean government bonds. If the government reduces the share of ultra-long-term government bonds in its issuance plan next year to below 30%, then demand for this maturity might rebound.