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Korea's Central Bank Comments Dampen Rate Cut Hopes

South Korea's central bank chief on Tuesday said an expected annual current account deficit and high inflation favored higher interest rates, although a slowing economy supported the case for steady or lower rates.

His comments, which traders took to suggest interest rates would not fall soon, sent bond futures prices down sharply in early trade. June treasury bond futures fell as much as 25 ticks to 106.97.

"This year's current account is highly likely to be in deficit, which is signaling the need for a reduction in money supply," Bank of Korea Governor Lee Seong-tae told a forum of business executives. "When taking into account consumer prices alone, we see a sign that interest
rates need to be raised," he added.

His latest comments are generally in line with his remarks earlier in the month when his warnings about high inflation dashed expectations among investors of an early cut in interest rates on concern that Asia's fourth-largest economy will slow in line with a global slowdown.

"As of the first quarter, the economy during the first half is expected not to be as strong as in the second half of last year, which suggests interest rates need to stay on hold," Lee said.

He later told a small group of reporters he meant to say the economic situation favors steady or lower interest rates.

His comments come amid heightened volatility in the local bond market following contradictory comments by President Lee Myung-bak and his finance minister about rising South Korean inflation.

President Lee said at the weekend that containing inflation was more urgent than maintaining rapid economic growth. That helped drive down bond prices on Monday as investors saw less chance of an interest rate cut.

His comments appeared to contradict remarks last week by the finance minister that tightening money supply was not the proper tool to fight current cost-pull inflation, which on Friday helped push up bond prices.

The Bank of Korea held its benchmark interest rate steady at 5.0 percent in early March for a seventh consecutive month, and plans to next review the rate on April 10.