Analysis: Korea threat seen rhetoric but risk still watched

By Peter Apps, Political Risk Correspondent

LONDON (BestGrowthStock) – Political analysts and local markets may largely write off North Korea’s threat of a nuclear “sacred war” as rhetoric, but the risk of conflict on the peninsula has clearly reached the radar of global investors.

North Korea’s minister of armed forces accused South Korea of trying to start a war by conducting live fire drills on Thursday, saying Pyongyang was prepared to wage war against its neighbor “at any moment necessary.”

While local Korean and Japanese markets have tended to shrug off repeated threats from Pyongyang, partly because of a perceived very low risk of war already priced into assets, wider global investors have begun to take much more notice.

“In terms of rhetoric, this is the sort of thing we’ve heard before,” said Alastair Newton, a former British diplomat and senior Cabinet Office official who is now political analyst for Japanese bank Nomura. “But there’s no doubt we are… in the most dangerous situation on the Korean peninsula in decades.”

Tensions have risen steadily after the sinking of a South Korean corvette in March and the shelling last month of an island. South Korean President Lee Myung-bak said earlier on Thursday its military should launch a “merciless counter-attack” if the North attacked again.

While most agree war is a remote possibility, events on the peninsula now figure in research notes from major banks such as Bank of New York Mellon, Royal Bank of Canada and Sweden’s SEB, to name but three.

The November 23 artillery exchange hit markets around the globe already made nervous by Ireland’s economic woes [ID:nL3E6MN07F].

It helped push gold to a one-week high, U.S. Treasuries up 0.4 percent and U.S. and European stock futures down between 0.4 and 0.9 percent. The Korean won and Japanese yen also suffered.

Investors and analysts shrugged off the latest statements, which had no impact on thin pre-Christmas trade. Experts said the threat was not in itself a huge departure from previous rhetoric — but warned the secretive North Korean regime remained all but impossible to predict.

BLUFF ASSUMED

“Of course you would always assume that they are bluffing but with these guys you never know,” said Oliver Thraenert, senior fellow at the German Institute for International and Security Affairs.

For now, the situation may have plateaued. The South has demonstrated a degree of strength after the shelling last month, while the North has held back from its threats to retaliate militarily for the live firing.

But it would not take much to stoke the fire further. The South’s government will come under growing domestic political pressure to retaliate if the North attacks again.

“If we do get more shelling or other major provocations, I think you could see a stronger retaliation from the South,” said Control Risks’ North Asia analyst Andrew Gilholm.

“I don’t think it would be a … widespread attack on Pyongyang or anything like that. I think it would simply be targeting the border area facilities that had fired. That would obviously be worrying but I still think it would be contained short of a war.”

Even so, markets would be shaken in quiet holiday trade — leaving investors even more cautious than usual as they leave their trading positions over the long end-of-year break.

NIGHTMARE SCENARIO

“It means you trim back on your riskiest assets, build safe haven positions like U.S. Treasuries,” said Nigel Rendell, foreign exchange strategist at Royal Bank of Canada. “Some guys are going away for 10 days and you don’t want to be caught out.”

The nightmare scenario — very unlikely but still a question mark in the minds of investors especially in far-away places — would be a return to all-out war, with devastating human and economic consequences.

“That would bring with it a considerable danger to the existence of the North Korean regime — and our base case scenario is that the regime is logical and still wants to ensure its own survival,” said Nomura’s Newton, who visited Pyongyang earlier this year.

(Additional reporting by Fredrik Dahl in Vienna, Editing by Sonya Hepinstall)

Analysis: Korea threat seen rhetoric but risk still watched