The Bank of Korea is expected to raise its base rate by an additional 25bp from the current 2.75% to 3.00% at the Monetary Policy Board meeting scheduled for August 27. While headline inflation has moderated, analysts argue that underlying inflationary pressure and solid growth momentum will prompt the central bank to act preemptively in August rather than defer policy response to October.

iM Securities said in a report published on August 19 that the Bank of Korea will continue its consecutive rate-hike stance with a 25bp increase at the August meeting. The firm assesses that the current macro environment is too strong in terms of inflation and growth to end with a one-off insurance-style hike, yet not extreme enough to warrant a big-step move.

Kim Myung-sil, an analyst at iM Securities, said, “Based on macro data on inflation and growth, the current rate-hike cycle is stronger than the gradual normalization of 2017–2018 but weaker than the inflation crisis of 2021–2023.” She added, “Given that the aim is to prevent lagging inflation on the back of growth recovery, the closest analogue is the 2010–2011 cycle.”

Kim noted, however, that “the key difference is that the Bank of Korea already knows the lessons of 2010,” adding that “the probability of a consecutive hike in August is higher than back then, because waiting to confirm inflation before acting risks a delayed response.”

South Korea’s consumer price inflation slowed to 2.8% in July, driven by falling supply-side prices including international oil prices and public utility charges. However, core inflation excluding food and energy stood at 2.6%, and personal services inflation recorded 3.5%, indicating that service-driven underlying price pressure persists.

Kim said, “If the hike is delayed until October, there is a significant risk that supply-side inflation from a rebound in international oil prices could recombine with underlying inflation, causing monetary policy to lag behind prices.” She stressed that “a consecutive hike in August has the benefit of blocking premature easing of financial conditions driven by expectations of an end to the rate-hike cycle, and effectively suppressing inflation expectations.”

Bond Market Reacts More to Supply-Demand Than Policy

Meanwhile, in the month following the base rate hike, the bond market has responded more strongly to fiscal and government bond supply-demand factors than to the policy rate itself. Short-term yields, which are sensitive to monetary policy, have stabilized, while ultra-long maturities have continued to weaken, rapidly widening the spread between short- and long-term yields.

According to final quoted yields from the Korea Financial Investment Association, the 3-year KTB yield closed at 3.847%, the 10-year at 4.382%, and the 30-year at 4.751% on the previous trading day. Compared with levels following the Bank of Korea’s rate hike on July 16, the 3-year yield has fallen 5bp, while the 10-year has risen 5bp and the 30-year has surged 23bp.

With short-term yields falling and long-term yields rising, the yield curve has steepened in a bear steepening pattern. The spread between 3-year and 10-year yields widened from 39bp at end-June to 54bp on August 18, the widest since October 2021. The 10-year to 30-year spread also widened from 26bp to 37bp over the same period.

SegmentEnd-June SpreadAug 18 SpreadChange3Y–10Y39bp54bp+15bp10Y–30Y26bp37bp+11bp

Note: Based on Korea Financial Investment Association final quoted yields. The 3Y–10Y spread is at its widest since October 2021.

Kim Myung-sil said, “The most notable feature of the recent South Korean bond market is that the rise in yields is concentrated in the long end rather than the overall level of rate increases,” adding that “the bear steepening is driven by supply-demand factors rather than policy.” Her logic: if concerns about additional rate hikes were the sole cause, 2- to 3-year yields, which are sensitive to policy rate expectations, should have risen as well.

Citing the Bank of Korea’s Financial Stability Report, Kim said, “The term premium, which stood at around 0.2% at end-2024, expanded by roughly 120bp to 1.4% by end-May this year, while expected short-term rates rose only 10bp over the same period.” She added, “The 10-year yield also reflects fiscal and global long-term rate burdens, but the 30-year is carrying a much stronger supply-demand premium.” The term premium refers to the additional yield investors demand as compensation for holding bonds over the long term.

Behind this premium expansion lies a structural shift in demand from long-term institutional investors such as insurers and pension funds. The explanation is that the steady, rate-insensitive inflows that previously existed have weakened, and buying now only materializes when yields rise sufficiently.

The government bond issuance plan and fiscal spending scale to be included in the budget proposal at the end of this month are also variables. Kim Sung-soo, an analyst at Hanwha Investment & Securities, said, “We view the 4.30% range as an appropriate level for the 10-year KTB ahead of the budget announcement,” adding that “the early-month strength in 10-year bonds is likely a temporary phenomenon.” He noted, “With solid growth capping the downside for yields and fiscal uncertainty present, investors need to remain cautious about buying long-term government bonds.”

U.S. long-term yields are also an unfavorable factor. When U.S. long-term rates remain elevated, South Korean long-term bond investors also demand higher yields, taking into account relative rates and currency hedging costs. Kong Dong-rak, an analyst at Daishin Securities, said, “Despite indicators suggesting inflation is stabilizing, U.S. long-term yields are struggling to find stability at elevated levels,” attributing this to “distrust in the Federal Reserve’s policy trajectory and persistent government bond supply-demand burdens in the second half, concentrated in the long end.”

Kong said, “Without stabilization in the U.S. yield curve, there can be no stabilization in yields,” forecasting that “downward stabilization of yields will proceed very slowly.”

However, some analysts note that unlimited steepening is unlikely. Kim Myung-sil expects the 3Y–10Y spread to trade in a 45–60bp range and the 10Y–30Y spread in a 25–40bp range. She said, “If the 3Y–10Y approaches 60bp and the 10Y–30Y approaches 40bp, investors should consider taking profits or switching to flatteners rather than building new steepener positions.”