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Bank of Korea lifts rates, seen on hold for some time

SEOUL - South Korea's central bank raised interest rates on Thursday to a 7-1/2-year high and appeared to keep the door open for more tightening, but analysts said the first rise in a year could also be this year's last.

The central bank raised its benchmark interest rate KROCRTECI by a quarter of a percentage point to 5.25 percent, the highest since February 2001, its eighth rate rise since late 2005 and the first since last August.

Bank of Korea Governor Lee Seong-tae said the rate rise aimed at containing inflation expectations and that it was too early for the central bank to lower its guard on prices.

‘It is not yet time for monetary policy to focus only on slowing economic growth because the inflation risk remains in place,’ Lee told a news conference.

But analysts refused to take the tough rhetoric at face value and said cooling global economy and faltering domestic demand made more rate increases unlikely this year.

‘On the surface, the governor's comments sound like keeping the door open for further increases, but I take them as just explaining today's decision,’ said Kong Dong-rak, a fixed-income analyst at Hana Daetoo Securities.

Government data released after the rate announcement showed South Koreans were most pessimistic since late 2000 about the national economy and their living standards.

A sharp retreat in oil prices CLc1 from record highs hit last month also weakened the case for further policy tightening, analysts said.

Treasury bond future prices KTBc1 kept fluctuating wildly as investors digested Lee's comments, while stocks .KS11 extended losses on worries higher borrowing costs would squeeze corporate earnings.

Seven out of 12 economists polled by Reuters this week had predicted a quarter point rise in the base rate, which applies to the central bank's weekly seven-day repurchase agreement deals, but five saw rates left on hold.

WEAK DOMESTIC DEMAND

Governor Lee Seong-tae said inflation, which hit a near-decade high of 5.9 percent in July, would stay above his bank's 2.5-3.5 percent target for a considerable period.

‘(The central bank) raised the rate to reduce as much as possible the spreading of the high consumer price growth into inflation expectations,’ he said.

Analysts said mounting evidence of economic weakness should persuade the central bank to hold fire in months ahead, perhaps well into next year.

‘I think the Bank of Korea felt it needed to follow through on its very hawkish statements over the last several months,’ said Frederic Neumann, economist at HSBC.

‘It would also suggest that this is the last hike for quite some time. Perhaps it deemed that its credibility was at stake and therefore it was going to hike in order to anchor inflation expectations.’

The National Statistical Office reported its measure of consumer sentiment in July fell to a seasonally adjusted 85.9, the lowest since December 2000, from 86.8 in June. A reading below 100 means most consumers were pessimistic.

The rate decision came two days after the US central bank left rates unchanged, citing both growth and inflation risks.

South Korea's economy grew a seasonally adjusted 0.8 percent in the second quarter from the previous quarter, beating market expectations, but exports contributed nearly two-thirds of the growth, central bank data showed last month.

This means the economy could slow sharply once global demand for its ships, cars, electronics and other goods cools, as feared.

Analysts say that even though South Korea's exports have so far held up remarkably well, signs of a drop in global demand were becoming evident in data recently released by Japan and other major exporting nations.