Inflation Risk Intensifies and Life Insurer Demand Weakens, South Korea's 30-Year Government Bond Yield Hits Historic High

According to Zhitong Finance APP, the South Korean government bond market is under pressure due to high energy prices exacerbating inflationary pressures and weakening demand from life insurance companies. The 30-year government bond yield rose to 4.67%, marking the highest level since the introduction of this tenor in 2012; the 2-year government bond yield also inched up to 3.64%.

As geopolitical tensions in the Middle East continue to drive up international oil prices, South Korea, which relies heavily on imported energy, is facing increasing inflation risks. Data released earlier this month by the Korean statistical agency showed that the consumer price index (CPI) rose 2.8% year-on-year in July, falling below 3% for the first time in three months. In May and June, influenced by surging international oil prices due to the Middle East conflict, South Korean inflation stayed above 3% for two consecutive months, reaching as high as 3.2% in June—a 30-month peak. With the US and Iran signing a memorandum of understanding to end hostilities, international oil prices have receded and government price stabilization measures have taken effect, bringing inflation back to the 2% range.

However, core CPI, which excludes food and energy, accelerated to 2.6% year-on-year in July from 2.5% in June, reaching its highest level since December 2023. This increase was mainly driven by rising prices of IT equipment, electric vehicles, and travel-related services.

For South Korea, core inflation remains elevated and agricultural product prices continue to rise, making the foundations for a decline in overall inflation rather fragile. The risk of upward price movements still exists. Should tensions in the Middle East flare up again, surging oil prices could reignite inflation in South Korea at any moment.

In a statement following their price assessment meeting earlier this month, the Bank of Korea stated that due to last year's base effect from discounts on mobile communication charges, consumer inflation in August may rise. The Bank of Korea added that, given the uncertainties stemming from Middle East conflicts and persistent underlying price pressures, it will continue to closely monitor inflation developments.

In fact, the Bank of Korea had already warned in a report released in June that, even if the Middle East conflict ends and international oil prices fall, factors such as consumption recovery and rising wages could keep inflation elevated for a period of time. The report predicts that improved performance among IT companies will further boost consumption momentum and that economic recovery trends will persist. Recently, the trend of wage increases in certain IT sectors may spread through the industry as a whole, exacerbating inflationary pressures further.

The remarks made on Tuesday by outgoing Bank of Korea Senior Deputy Governor Ryu Sang-dae echoed this warning. Ryu noted that, with the semiconductor boom, rising wages in the IT sector are translating into persistent inflationary pressures. He stated: “It is concerning that the wage increases in the IT sector are becoming a source of upward price pressures. While the magnitude of price increases may not be significant, their durability will be strong.” This implies that the consumer price index is likely to remain above the Bank’s 2% target for a prolonged period.

Ryu also stated that, as economic growth continues feeding into core inflation, the likelihood of the Bank of Korea raising its benchmark rate further is “very high” unless there are extreme shocks. Just last month, the Bank of Korea raised the benchmark rate by 25 basis points to 2.75%, marking its first tightening move in three and a half years and indicating that further increases remain on the table. Bank of Korea governor Rhee Chang-yong commented at the time that every upcoming meeting would be a “live discussion,” with all options open. Currently, most market participants are focused on the Bank’s next rate decision meeting on August 27, with the odds of consecutive rate hikes still generally factored into expectations.

Ryu added that the recent stabilization of the Korean won, coupled with the decline in Korea’s benchmark index Kospi, “gives some leeway to the Monetary Policy Committee members, but I don’t think these are key factors.” He said, “The main issues are whether core inflation will remain high, whether economic growth can be sustained, and the matter of financial stability.”

Apart from inflation risks, another major reason for the pressure on South Korea’s government bonds is the weakening of one key source of demand: life insurance companies. Due to changes in regulatory rules that have reduced the urgency to extend asset durations, South Korean life insurers have scaled back purchases of ultra-long-term government bonds.

Cho Yong-kyu, fixed income strategist at Korea ShinYoung Securities, said: “So far this year, demand has remained weak. Actual buying from insurance companies, particularly life insurers, has been quite subdued.” He added that the outlook for the bond market will partly depend on the global interest rate environment as well as Korea’s domestic government bond supply. “If the government reduces the share of ultra-long-term bonds in next year’s issuance plan to below 30%, then demand for this tenor may recover in the market.”