Feb. 9 (Bloomberg) -- South Korea's central bank raised its benchmark interest rate by a quarter percentage point to a three- year high to keep inflation from accelerating.

Bank of Korea Governor Park Seung and his six fellow policy makers raised the overnight call rate to 4 percent at a meeting in Seoul today, the third increase in five months. Five of 12 analysts polled by Bloomberg News expected the decision.

Park, whose four-year term ends March 31, ignored calls by government officials such as Vice Finance Minister Kwon Tae Shin to keep rates unchanged. The governor expressed confidence that Asia's third-largest economy will expand at least 5 percent this year, the fastest in four years, even as a stronger won threatens to curb export growth.

``Today's decision is a very strong recognition that the Bank of Korea is backing a recovery in the domestic economy,'' said Huw McKay, senior economist at Westpac Banking Corp. in Sydney, who expected a rate increase. ``It shows they're prepared to back that forecast in the face of a strong won exchange rate.''

South Korea's Kospi index rose 0.8 percent to close at 1321.66 at 3 p.m. The benchmark, which soared 54 percent last year, reached a record 1426.21 on Jan. 17. The won, which rose 6.2 percent in the past 12 months, fell 0.2 percent to 972.70 against the dollar.

Bonds also rose on optimism the won's strength will prompt the bank to pause in raising rates. The yield on the benchmark three-year government bond fell 10 basis points to 4.85 percent at 3:30 p.m., according to the Korea Securities Dealers Association. The yield reached the lowest level since Oct. 21.

Uncertainty Lifted

``The rate increase lifted the uncertainty that has long kept investors from increasing their holdings,'' said Shin Joo Hyun, a fund manager at Industrial Bank of Korea in Seoul. ``The view is now that raising rates further is hard given that a stronger won clouds the economic outlook.''

Central banks in Asian countries such as India, Thailand and Malaysia have raised interest rates in past months as rising domestic demand and soaring oil prices threaten to fan inflation. The Bank of Japan today held rates at almost zero as it gathers more evidence that deflation has ended.

The U.S. Federal Reserve raised its main lending rate to 4.5 percent on Jan. 31.

Consumers increased spending at the fastest pace in a decade in December and companies boosted investment, the National Statistical Office said on Jan. 27. A separate report today showed consumer confidence rising to a nine-month high in January.

`No Problem'

Rising spending by consumers and businesses may stoke inflation this year, according to the central bank. Consumer prices rose in January at the fastest pace in 10 months, gaining 0.8 percent from December. From a year earlier, prices rose 2.8 percent.

Inflation will accelerate to 3 percent this year from 2.7 percent in 2005, the central bank said in December. Core inflation, which excludes food and energy, will probably accelerate to 3.3 percent in the second half of 2006 from 2.1 percent in the first six months, it forecast. The central bank targets core inflation of 2.5 percent to 3.5 percent.

``The economy is recovering faster than expected and the monetary policy should gradually move to a neutral stance to reduce the side effects of a low interest rate policy,'' Park said at a press briefing in Seoul. ``There are some negative factors like the won gains and higher oil costs but after our studies, we confirmed that there'll be no problem in achieving a 5 percent growth despite those factors.''

The economy grew 4 percent last year, the central bank said.

Government Opposition

With today's increase, Park has brought the call rate back to where it was when he became Governor in April 2002. Park raised interest rates a month after taking over. He then went on to slash borrowing costs to record lows in 2004 as South Koreans were struggling to shake off the burdens of a credit-card binge that left many mired in debt.

Park, 69, increased borrowing costs even after some government officials expressed concern that such a move may stunt economic growth.

``It is advisable for interest rates to be maintained at the current level,'' vice minister Kwon said in an interview with a local cable television Feb. 7. He cited the rising won and higher oil prices as sources of concern for South Korea's economy. Finance Minister Han Duck Soo yesterday said he hopes the Bank of Korea won't ``tighten too much.''

A stronger won makes imported goods cheaper, easing pressure on consumer prices to climb. At the same time, it hurts sales for South Korean exporters such as Samsung Electronics Co. Exports, which account for about 40 percent of the economy, grew 4.3 percent in January, the commerce ministry said on Feb. 1.

To contact the reporter on this story: Seyoon Kim in Seoul at skim7@bloomberg.net

Last Updated: February 9, 2006 03:22 EST