S Korea's sudden rate hike surprises market

17:26, July 09, 2010      

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South Korea's central bank on Friday raised its key interest rate by 0.25 percentage point to 2.25 percent, marking the first rate hike since the global financial crisis amid a faster-than-expected recovery.

"The Monetary Policy Committee of the Bank of Korea (BOK) decided today to raise the Base Rate from 2.00 percent of its current level to 2.25 percent," the BOK said in a press release.


With regard to the decision, the BOK cited domestic economic activity that has been staying on an upward trend.

According to the central bank, South Korea's economy has been marking a faster-than-expected recovery on the back of cited brisk exports and strong domestic consumption and facilities investment.

The BOK said that the local economy grew over 1 percent on- quarter in the second quarter but with a growth rate of more than 7 percent on-year in the first half.

Although the presence of overseas risk factors, such as the fiscal problems in European countries, the growth pace is likely to be maintained.

"In the coming months, the (South) Korean economy appears set to register solidly-based growth, helped by the favorable development of exports and increasing consumption and facilities investment," the BOK said.

Despite the economic growth, South Korea is under growing inflationary pressures, the BOK said, citing it as the main drive for the rate hike.

In the future, upward pressures are expected to build continuously owing to the increase in demand-pull pressures associated with the continued upturn in economic activity, the BOK said.

According to Gov. Kim, there is a possibility that South Korea' s consumer price inflation (CPI) may grow by around 3 percent in the second half of 2010, and above the 3-percent level next year, while its growth has been kept at the target level around 2.5 percent during the first half.

With respect to the real estate market, Gov. Kim pointed that the scale of the growth in mortgage lending has widened, interpreting it as a risky signal.

"Looking ahead, the Committee will maintain the accommodative policy stance in such a way as to help the economy sustain its sound growth on a foundation of price stability," the BOK said, although it commented there will be no change in the accommodative policy stance despite the current rate hike.


The decision came at a monthly rate setting meeting presided over by Gov. Kim, putting an end to the rate freeze that has been kept for the past sixteen months.

Slashing the rate by a total of 3.25 percentage points between October 2008 and February, the BOK kept it frozen at the record- low level for sixteen consecutive months.

As it has been widely expected by local analysts that the rate hike will likely be conducted as early as August, the rate was widely forecast to stay frozen at the 2 percent level for July.

With the BOK's unexpected announcement, market participants interpreted it as the BOK's firm intention on a preemptive measure against possible price hikes based on strong confidence that the economy will keep its growth momentum down the road.

In late June, the South Korean government revised up its growth outlook for 2010 from 5.0 percent to 5.8 percent, which was followed by the International Monetary Fund (IMF) which hiked the outlook from 4.5 percent to 5.75 percent.

Based on the earlier-than-expected rate hike, local media in one voice expect it became more probable that the BOK will further revise up the key rate during the second half, at least once or twice.

Upon the BOK's abrupt announcement, the finance ministry said it will respect the decision, saying it expects limited impact on the market and it will monitor how the market reacts towards the decision.

South Korean conglomerates echoed the government's remarks, saying the rate hike will have a limited impact on them, though it may put a significant burden on small and medium enterprises (SMEs) .

South Korea's financial markets showed conflicting reactions towards the report, however, with the stock market regaining strength, adding around 1.43 percent as of the end of the Friday session.

The local currency, in addition, soared against the U.S. dollar, up as much as 13.30 won at the close and breaking above the 1,200- won level.

Following the decision, local lenders said that they will pull up rates on loans, starting next week, while they are not decided with what to do with those on deposits yet.


Opposed to Gov Kim's remarks that the accommodative policy will be maintained, market watchers said the rate increase shows that the central bank is ending the current monetary policy stance.

"The rate hike is seen as the start of the normalizing process, " Gong Dong-rak, a fixed-income analyst at Taurus Investment & Securities Co, was quoted as saying by the Yonhap News Agency.

Analysts jointly expect that there will be additional rate hikes within this year, but the pace and the timing would not be fast due to lingering overseas economic uncertainties.

"The next rate hike may come either in September or October, and the rate may reach as high as 2.75 percent," Park Jong-yun, analyst at Woori Securities, told local media.

"If the global economic conditions do not become worse, the BOK will likely hike the rate two or three times gradually," Lim Ji- won, an economist at JP Morgan, also told Yonhap.

Based on expert forecasts, local market participants are expecting additional rate hikes down the road, interpreting it as the BOK's confidence over continued economic growth as well.

Source: Xinhua


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