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HONG KONG, Sept 17 (Reuters) - Korean cross currency swaps jumped on Thursday as investors seeking yield piled in funds, a trend expected to continue as signs of further improvement emerged in Asia's fourth biggest economy.
The tightening basis is also being accompanied by a fall in South Korean credit default swaps.
The cost of borrowing dollars in other markets continued to decline steadily as central banks in Europe ignited hopes that easy monetary conditions will extend for some time.
One-year dollar/won cross-currency swaps rose more than 10 basis points (bps) to 1.78 percent, having risen nearly half a percentage point this month.
As a result the swap basis, the approximate returns for foreigners swapping dollars for won and receiving interest rate swaps, was about 10 bps narrower at 1.65 percent.
The basis between the one-year CCS and the one-year IRS has narrowed from around 215 basis points at the start of the month and around 350 bps in mid-June.
South Korean five-year credit default swaps fell 16 basis points (bps) to 100/110 bps, an indication these arbitrageurs were removing the sovereign risk from their trades.
"Foreigners are buying local bonds and paying cross currency swaps to take advantage of the local currency swap spreads," said a Seoul-based trader.
"Global risk appetite is improving and the excess liquidity is flowing into Korea."
The South Korean won has risen to within striking distance of a one-year high of 1,200 to a dollar as robust foreign funds inflows continued.
South Korean Finance Minister Yoon Jeung-hyun said on Thursday the rise was expected with the stock market hitting peaks and this had resulted in increased foreign currency liquidity.
"The sentiment towards Korea is improving and the availability of the dollar globally is continuing to improve," said David Mann, a strategist at Standard Chartered Bank.
"As people are more convinced of the recovery it is likely to continue to narrow."
And despite assurances by the finance minister that it is not time to raise interest rates yet, 91-day certificate of deposit (CD) rate struck a seven-month high as money markets retained bets the central bank will tighten monetary policy.
The short-end CD rate rose 1 basis point to close at 2.64 percent, the highest since February 12, when the central bank last cut rates and hinted at further easing.
One-year Korean IRS, also rose one bps to 3.43 percent after retail sales in August jumped at the fastest clip in seven months, providing fresh evidence of recovering domestic demand.
Flush liquidity in South Korea, an outcome of the expansionary policy, has also led to calls for liquidity controls from a leading think-tank.
"To prevent asset markets from overheating, which may happen in line with an economic recovery ... it is necessary to actively consider pre-emptive liquidity control," the Korea Development Institute (KDI) said in a research paper.
In Singapore, the cost of three month dollar funds fell to 0.30 percent from 0.30143 percent.
These rates tracked the lower Libor rates which fell as the European Central Bank prepares to offer another unlimited injection of one-year funds and following comments from Bank of England Governor Mervyn King suggesting the bank had more room for policy easing. (Reporting by Umesh Desai; Editing by Jan Dahinten)