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South Korea Averts Recession, Rate Seen at Bottom

South Korea's economy averted a recession in the first quarter thanks to pump-priming and rate cuts, the central bank said on Friday, supporting market bets that interest rates had troughed.

A senior official at the Bank of Korea -- which is usually extremely conservative in its assessments -- made a rare reference to an "upside risk" to the economy, pointing to early signs of the global economic and financial crisis abating.

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Korea, Korean Flag

The central bank estimated gross domestic product to have expanded by a seasonally adjusted 0.2 percent in the first quarter over the previous quarter, turning around from a revised 5.1 percent fall in the last three months of 2008.

"There is not only a downside risk; we also see an upside risk because of changing trends in the United States," Kim Jae-chun, the central bank's head of research, told reporters.

South Korean stocks and the currency rose as investors priced in Asia's fourth-largest economy emerging from its worst trough in 11 years, while bond prices fell on speculation that the central bank could start to raise interest rates early next year.

Bank of Korea Governor Lee Seong-tae had said on Thursday that interest rates could still fall should the economy worsen, but bond analysts viewed the comment as an attempt to soothe bond investors rather than a warning of actual rate cuts.

Analysts believe the economy has passed the worst thanks to an unprecedented set of stimulus efforts, but predicted the recovery would only be gradual and remain dependent on the strength of advanced economies.

"The rapid fall in the economy has stopped thanks to effective government countermeasures," said Kwon Soon-woo, chief economist at Samsung Economic Research Institute.

"Since South Korea is not the epicentre of the crisis, it can emerge from the trouble first. The central bank may have to start absorbing liquidity with fast rate hikes," he added.

Since late last year, South Korean authorities have offered about $50 billion in fiscal spending plans -- more than 5 percent of annual gross domestic product -- and slashed interest rates by a total of 3.25 percentage points to a record-low 2.0 percent.

Bonds Hit By Supply, Rate Outlook

The central bank expects the economy would contract by 2.4 percent this year, its second-worst performance in modern history, but investors shrugged off the widely expected downgrade from its previous forecast for 2 percent growth.

It said the economy would return to growth of 3.5 percent in 2010, down from a forecast for 4.0 percent made in December.

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The Seoul stock market rose to a six-month high and the won hit a three-month high against the dollar on investor hopes for an economic recovery. Both were headed for their longest streak of gaining weeks in nearly two years.

June treasury bond futures fell slightly and the 1-year/5-year interest rate swap spread further widened to its broadest in nearly six years to 100 basis points on Friday from 98 basis points on Thursday as investors priced in the start of an interest rate raising cycle.

"In theory the governor is right to say the chance is always there for additional cuts, but I think his comment was more aimed at mitigating the market's concerns about increasing supply," said Hwang Tae-yeon, a fixed-income analyst at Tong Yang Securities.

South Korea's parliament has been deliberating the government's plan to expand fiscal spending by nearly 20 trillion won ($15.2 billion) this year to boost domestic demand, funded mostly by additional bond issuances.