Government bond yields in South Korea continue to rise, reflecting the Bank of Korea's shift to a tightening cycle and expectations for further interest rate hikes. This increase is expected to push loan interest rates into a significant upward trend in the second half of the year. As the central bank raises rates and the government maintains its stance on managing household debt, the financial burden on borrowers is likely to grow.
According to the Korea Financial Investment Association, the yield on three-year government bonds closed at 3.867% on July 21, up 93.2 basis points from the end of last year (2.935%). Similarly, the yield on ten-year government bonds rose from 3.385% to 4.328%, an increase of 94.3 basis points during the same period.
This rise in government bond yields has been driven by geopolitical risks in the Middle East, inflation concerns, and expectations of interest rate hikes. Notably, the Bank of Korea raised its benchmark rate from 2.50% to 2.75% on July 16 and hinted at the possibility of further increases, intensifying upward pressure on bond yields.
The increase in market interest rates raises banks' funding costs, which in turn leads to higher loan interest rates. For instance, the yield on one-year bank bonds (AAA, unsecured) rose from 2.816% at the end of last year to 3.737% recently, an increase of 92.1 basis points. The one-year bank bond yield is a key indicator of banks' short-term funding costs, and rising costs can exert upward pressure on loan reference rates such as the COFIX.
The key reference rate for mixed-rate (fixed-rate) mortgage loans, the five-year bank bond yield, also increased from 3.495% at the end of last year to 4.480%, while the three-year bank bond yield rose from 3.205% to 4.258%, a jump of 105.3 basis points.
Loan interest rates are showing signs of rising again. According to the Bank of Korea, the interest rate on new household loans from deposit banks fell from 4.51% in March to 4.43% in April but rebounded to 4.46% in May. As market interest rates continue to rise and the benchmark rate is increased, upward pressure on loan interest rates is expected to intensify.
In this context, the burden on borrowers is anticipated to increase. As of the end of May, the proportion of variable-rate loans among household loans was 75.4%, with variable-rate mortgages making up 58.4%. Variable-rate loans are structured to reflect changes in reference rates like COFIX relatively quickly, meaning that if the trend of rising benchmark rates continues, borrowers with variable rates are likely to face increased interest burdens.
It is also expected that banks will raise their lending thresholds. The Bank of Korea indicated that the comprehensive index of banks' lending attitudes is projected to drop to -7 in the third quarter, down from -1 in the first quarter and -2 in the second quarter. A negative lending attitude index indicates a tightening of lending criteria. The index for household mortgage loans is expected to be -14, while the index for general household loans is projected at -11, with household credit risk remaining high. The Bank of Korea analyzed that the deterioration of repayment capacity among vulnerable borrowers and the government's household debt management policy will influence banks' tightening of lending standards.
As loan interest rates rise and lending criteria tighten, the demand for funds among borrowers is expected to persist, while the conditions for securing funds will become increasingly challenging. The survey indicated that despite the tightening of lending standards, demand for credit loans for living expenses and stock market investments is expected to continue. In contrast, housing-related loans are projected to decline due to increased regulations and rising interest rates.
Market analysts believe that the upward trend in bond yields will likely continue for the time being due to the shift to a tightening cycle. Hana Securities stated that if the second-quarter economic growth rate hovers around 0.4% compared to the previous quarter, there is a strong possibility that the Bank of Korea will implement consecutive interest rate hikes in August. Park Jun-woo, a researcher at Hana Securities, noted, "If expectations for further interest rate hikes persist, the yields on three-year and ten-year government bonds by the end of the year could rise to levels 10 to 20 basis points higher than the previous forecasts of 4.0% and 4.3%, respectively."
* This article has been translated by AI.
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