FxWirePro: Rising inflation may trouble Korean currency, BoK likely to remain unchanged - KRW CCS flattened on deprived foreign investments

After soft industrial production data for January, now inflation for south Korea is lined up tomorrow to disturb KRW.

Output declined by a seasonally adjusted 1.8% MoM in January, a relatively sharp turn from December's 0.5% pace, which was in fact downgraded from a 1.3% advance.

The CPI in South Korea was decreased 0 percent in January of 2016 over the previous month. It is scheduled to be announce tomorrow followed by Friday's FX reserves and the forecasts of CPI MoM for February are at 0.1%.

This would make BoK, The BoK kept its benchmark rate steady at 1.5% in December for the sixth straight month, as widely expected.

With growth and inflation basing, expansionary budget, we think the BoK will likely remain on hold in 2016. Furthermore, with BoK paying greater attention to financial stability risks from high household debt (84.3% of GDP at end-2014), we see little urgency to ease again and we think BoK will tolerate more KRW weakness as a result.

The KRW Cross Currency Swap curve has continued to flatten and has become further inverted. This could be a result of a lack of both asset swap flows - for overseas investments at the front-end given the worsened growth outlook, and issuer flows - with low incentives for hard currency bond issuances at the mid-to-long end.  

However, the market may also have priced in too much of an impact of a potential lift on banks' forward positions.

We do not expect an influx of asset swap flows at the short-end into KRW assets with the pick-up not appealing. We suspect the current caps are not binding, as suggested by the much reduced short-term foreign debt to total debt ratio at foreign bank branches.

One trigger for the CCS curve to steepen is a re-price of the policy impact pressuring down front-end CCS, though issuer flows remain a swing factor.