South Korea Holds Rates, But Warns on Inflation

South Korea's central bank held interest rates steady for a 10th consecutive month on Thursday, as expected, but warned Asia's fourth-largest economy faced a bigger risk from rising inflation than a domestic slowdown.

Bond futures prices extended losses after the Bank of Korea issued the warning on inflation in a statement after holding its benchmark rate unchanged at 5.0 percent.

Korea, Korean Flag
Korea, Korean Flag

Governor Lee Seong-tae is due to hold a news conference later in the session.

"Consumer price growth is spreading into a wider range of products," the Bank of Korea said in a statement. "Under the current situation of high oil prices and high exchange rates (against the won), we view upside inflation risk as being bigger than a downside economic growth risk."

The widely expected decision came despite a 7-year high in local consumer inflation on record oil prices and money growth picking up, and as central banks in some Asian countries are raising credit costs to slam the brakes on soaring prices.

Analysts said chances were still low for the Bank of Korea raising interest rates soon due to worries that lifting interest rates to tackle the largely cost-driven inflation could kill local demand, already sagging because of rising prices.

"Inflation pressure has risen sharply recently and the central bank's governor is sure to focus on that during the press conference soon. But the governor will also be careful not to indicate a future interest rate hike as domestic demand is still unstable and turning towards a slowdown," said Lee Sung-kwon, chief economist at Goodmorning Shinhan Securities.

"As the outlook for the country's monetary policy remains unclear amid these conflicting issues, the central bank will probably leave interest rates on hold for the rest of the year," he added.

June treasury bond futures fell to as low as 105.62 after the warning remark, having traded around 105.80, compared with Wednesday's close of 105.95. The won and the stock market stood relatively steady from earlier levels.

In a Reuters poll, all 12 economists had expected the central bank to hold rates steady.

The Bank of Korea had lifted its benchmark rate by a total of 1.75 percentage points between October 2005 and August last year to keep strong money growth from raising inflation expectations and to help cool the local housing market. President Lee Myung-bak warned this week that the country, lacking energy and raw materials supplies on its own territory, could face its roughest patch since the 1997 Asia financial crisis due to a "resource crisis".

In early May Governor Lee issued strong warnings about rising inflation, but at the same time presented a glum outlook for economic growth by saying the central bank's forecast could be lowered in July.

The Bank of Korea had forecast this year's gross domestic product would expand 4.7 percent after a better-than-expected 5.0 percent gain in 2007, but Lee said growth would probably come below 4.5 percent.

The finance ministry has also said it would likely cut its 6 percent growth target, which analysts have said is unrealistically high, next month.