Boston, MA -- (SBWIRE) -- 07/04/2013 -- Core Views

South Korea is likely to benefit from an uptick in the regional economic cycle, stemming particularly from China. That said, we do not expect this momentum to last into H213. We believe that the structural deficiencies in China, which have yet to be ironed out, are likely to come to the fore again and exert downside pressure on its economy. Consequently, we expect to see consensus expectations for 2013 (currently 3.4%) eventually start to move towards our 3.0% target as the year unfolds.

With inflation likely to remain under control and the economic recovery expected to stall, we now expect one 25 basis point (bp) cut in the benchmark base rate by the Bank of Korea to 2.50% in the months ahead.

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Despite having been one of the regional underperformers in recent years, we still expect further weakness in South Korea's housing market. Structural downside pressure in the form of a supply overhang situation and deteriorating demographics will continue to push prices lower.

Despite witnessing an improvement in South Korea's household debt profile, we believe that the country's deleveraging cycle is still in its nascent stages. With both consumers and banks turning increasingly cautious towards the economy, Korean consumption spending is likely to remain constricted.

A marked improvement in Korea's external debt exposure in recent years has stoked foreign interest in the Korean government bond market. Notwithstanding the risks that stem from an increase in foreign participation, the fact that foreign central banks (with longer term investment horizons) have been the protagonists behind the surge in Korean government debt holdings, we believe that there is less likelihood of foreign capital outflows, and consequently less depreciatory pressure on the won in times of economic stress.

Newly elected president Park Geun-hye's policies exude sensibility and pragmatism. The chaebol reforms that were widely promulgated during her presidential campaign are likely to be immaterial, given the adverse economic ramifications they may entail. Despite the bellicose attitude that North Korea has been exhibiting, we expect Park to adopt a largely conciliatory posture towards Pyongyang, which may eventually lead to a reacceleration in economic ties between the two Koreas.

Forecast Changes

Given our expectations towards inflation and economic performance, we have seen fit to alter our interest rate expectations. We have turned dovish from our previously neutral stance and now expect the Bank of Korea to enact one 25bps cut to the benchmark interest rate in the months ahead.

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