Government spending and inflation concerns stemming from the Middle East are driving a sharp rise in government bond yields. As the need for fiscal expansion to support economic growth increases, analysts suggest that fears of 'fiscal inflation' are contributing to higher long-term interest rates. This shift reflects a broader change in the economic structure, moving beyond mere expectations of recovery.
According to the Korea Financial Investment Association, on June 14, the yield on three-year government bonds was 3.654%, while the yield on ten-year bonds reached 4.085%. Compared to the current base rate of 2.50%, these figures are 115.4 basis points and 158.5 basis points higher, respectively. The ten-year yield has hit its highest level since September 30, 2022, marking a peak not seen in approximately three years and seven months.
The recent rise in bond yields cannot be solely attributed to a recovery in the economy. With the country's GDP growth rate exceeding expectations in the first quarter and rising international oil prices due to heightened tensions in the Middle East, supply-side inflation pressures are increasing. Market participants are considering the possibility that the Bank of Korea may shift towards raising interest rates in response to these inflationary pressures.
Additionally, the government's expansionary fiscal policy is exerting upward pressure on long-term interest rates. While the government emphasizes the need for proactive fiscal management to address economic risks from the Middle East conflict, concerns are growing that even with increased tax revenues, the issuance of government bonds may not decrease as anticipated. Analysts suggest that the sequence of increased fiscal spending leading to greater bond supply and subsequently higher interest rates is already being priced into the market.
Fears of fiscal inflation are also resurfacing. If the government expands its budget through large-scale bond issuance, it could increase market liquidity, potentially leading to upward pressure on prices in the medium to long term. This concern is particularly relevant given the recent supply shocks from the Middle East, which are contributing to inflationary anxieties in the market.
In the bond market, experts argue that this rise in yields should not be viewed merely as an 'overshooting.' Kim Myung-sil, a researcher at iM Securities, stated, "The simultaneous emergence of strong semiconductor exports, increased investment in artificial intelligence (AI), expansionary government spending, a rising stock market, and recovering tax revenues suggests that the market is beginning to reflect the potential for an upward shift in the nominal growth framework of the economy." She added, "In the bond market, nominal GDP growth is more significant than real growth rates." An increase in nominal growth rates could elevate the equilibrium levels of tax revenues, corporate profits, wages, prices, and interest rates.
Looking ahead, the trajectory of interest rates is expected to be influenced by tax revenue conditions and the size of next year's budget. If tax revenues improve, the burden of bond issuance may lessen, potentially alleviating upward pressure on interest rates. However, if next year's budget approaches 800 trillion won, long-term interest rates may find it challenging to decline significantly. Consequently, there are predictions that the yield on ten-year government bonds could remain in the 4% range for an extended period.
* This article has been translated by AI.
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