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South Korea raises rates

  • Story Highlights
  • All 12 economists in a Reuters poll expected the central bank to hold rates steady
  • Bank of Korea: Economy was expanding
  • Consumer expectation index rose to a 19-month high in July
  • Annual inflation stood at 2.5 percent in July
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SEOUL, South Korea (Reuters) -- South Korea's central bank surprised markets Thursday by raising interest rates a quarter of a point to a six-year high of 5.0 percent to halt an acceleration in money supply growth that is fueling inflation.

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The Bank of Korea's governor Lee Seong-tae, at a news conference Thursday, discussed the benchmark call rate.

Its first back-to-back monthly increase in rates sent stock and bond prices tumbling, although the markets recovered some ground after the Bank of Korea's governor suggested rates could now be put on hold for a while.

All 12 economists in a Reuters poll had expected the Bank of Korea to hold rates steady after a quarter-point rise in July, although most had forecast another increase later in the year.

"It is a big surprise. The Bank of Korea seems to be much more concerned over high liquidity than expected," said Park Sang-hyun, chief economist at CJ Investment & Securities.

"Liquidity is the 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."

Central bank figures on Monday showed the broadest L money supply measure grew 12.7 percent in June from a year earlier, the fastest since a 12.9 percent gain in February 2003.

However, Governor Lee Seong-tae told reporters the central bank felt the cycle of seven rate rises from late 2005 had done much of its job in slowing money supply growth. He indicated the central bank would hold fire for a while to assess future money trends.

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"We have raised the call rate target twice this year, three times last year and twice the year before, and I expect these to have an effect gradually over time," Lee told reporters.

"Even if liquidity growth does not change markedly in September, it will change gradually."

Treasury bond futures, which tumbled more than 50 ticks right after the decision was announced, recovered some of the losses to trade down about 30 ticks at 0527 GMT after Lee's remark on the effect of past rate increases.

On the Seoul stock market, the benchmark KOSPI (.KS11) index initially wiped out a 1.3 percent gain after the rate rise, then fluctuated, and was down 0.2 percent at 0520 GMT.

The won (KRW-) rose to 921.4 per dollar from Wednesday's close of 923.7 but slipped back to around 923 by 0525 GMT.

"I think the BOK advanced the timing of a rate hike that was already in mind and will stay on hold for the time being," said Ryu Seung-sun, an economist at Mirae Asset Securities.

"But it doesn't mean that the current cycle of tightening has concluded, because the expected effect from rate increases may not take place."

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

Government data released later underscored growing optimism among South Koreans about the economic outlook and their future living conditions, although yet another interest rate rise might take a toll in coming months.

The National Statistical Office's seasonally adjusted consumer expectation index, which measures how South Koreans feel about economic prospects and personal spending six months ahead, rose to a 19-month high of 103.8 in July from 101.2 in June.

The central bank affirmed its view that inflation would gather pace due to growing domestic demand and firmer raw material prices.

Annual inflation stood at 2.5 percent in July, which is at the bottom of the central bank's target for 2007-2009 of between 2.5 percent and 3.5 percent but above its forecast for this year of an average 2.4 percent.

Analysts have said the central bank's confidence that economic growth would accelerate over the rest of this year and next would guarantee a hawkish stance on inflation.

The Bank of Korea estimated last month that gross domestic product grew a seasonally adjusted 1.7 percent in the second quarter, the biggest gain since late 2005.

It has forecast that the economy, which derives more than half of annual output from the service sector, would grow 4.5 percent this year and then speed up in 2008, after expanding by 5 percent in 2006. E-mail to a friend E-mail to a friend

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