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South Korea Raises Interest Rates to Six-Year High

South Korea's central bank surprised markets on Thursday with its first ever back-to-back monthly rise in interest rates, aiming to rein in surging money growth, in a move which sent bond prices plunging but boosted the won.

A media department official at the Bank of Korea said its monetary policy committee decided to lift the overnight call rate target by 25 basis points to 5.0%, the highest since early July 2001 and the seventh increase in the current cycle.

All 12 economists in a Reuters poll had expected the central bank to hold interest rates steady after July's quarter percentage point rise, with most predicting the Bank of Korea would lift interest rates again this year.

The decision sent September treasury bond futures down as much as 53 ticks, while taking the won up to 921.3 against the U.S. dollar, compared with the previous close of 923.7.

"It is a big surprise. The Bank of Korea seems to be much more concerned over high liquidity than expected," Park Sang-hyun, chief economist at CJ Investment & Securities. "Liquidity is key to monetary policy in the coming months. If the liquidity issue does not show signs of slowing down, the central bank will raise interest rates again, probably in October or November."

The last time South Korea's central bank made consecutive changes to its call rate target was in 2001 when it cut rates in July, August and September. It began setting the call rate target in 1999.

The Bank of Korea maintained its economic outlook, saying in a statement that Asia's fourth-largest economy was expanding amid brisk exports and recovering private consumption.

It also affirmed its recently stated view that inflation would gather pace later due to growing domestic demand and firmer raw materials prices.

The Bank of Korea had raised the interest rate target by a total of 1.5 percentage points between October 2005 and July this year to cool rampant growth in money supply.

Analysts have said the central bank's confidence that economic growth would accelerate during the rest of this year and next year will keep it maintaining a hawkish stance on inflation.

The Bank of Korea estimated last month that gross domestic product grew a seasonally adjusted 1.7% in the second quarter from the previous quarter, exceeding market expectations and marking the fastest gain since late 2005.

It has forecast South Korea's economy, which derives more than half of annual output from the service sector, would grow 4.5% this year and faster in 2008 after expanding by 5% in 2006.

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