South Korea's Won Gains, Stocks Decline as Rates Raised to Curb Inflation

South Korea’s won rose for the first time in three days and stocks fell as the central bank raised the benchmark interest rate for a second time this year after inflation quickened to a 20-month high.

The Bank of Korea increased the seven-day repurchase rate by 0.25 percentage point to 2.5 percent. The currency earlier declined amid concern the government will impose measures to temper inflows of capital that threaten to drive up prices. Government bonds rose for a seventh day on expectations the central bank will delay the next rate increase to 2011.

“The market is still nervous,” said Gerrard Katz, head of foreign-exchange trading at Standard Chartered Plc in Hong Kong. “It awaits any measures Korea would take to control the inflow of hot money.”

The currency appreciated 0.2 percent to close at 1,129.47 per dollar in Seoul, according to data compiled by Bloomberg. It has climbed 7.2 percent since the end of June, the third strongest performance among Asia’s 10 most-traded currencies excluding the yen.

The Kospi share index fell 0.8 percent to a two-week low of 1899.13. Financial companies were among the biggest decliners, with KB Financial Group Inc., owner of the nation’s largest bank, falling 1.7 percent. Woori Finance Holdings Co. slumped 3.6 percent.

Inflation Risk

Bank of Korea Governor Kim Choong Soo dropped a reference to keeping borrowing costs “accommodative” after inflation surged past the central bank’s ceiling. Inflation will be 3 percent this year, higher than a July forecast of 2.8 percent, and accelerate to 3.4 percent in 2011 due to rising demand in the economy, Kim said last week. Six of 13 economists surveyed by Bloomberg had predicted the interest-rate increase, while the rest expected no change.

South Korea will announce capital control measures by the end of this year, Yonhap News reported today, citing Vice Minister Yim Jong Yong. The currency had fallen 2.1 percent over previous two trading days on concern the government will step up efforts to curb capital inflows, which this month drove the won to its strongest level since April.

Kim Song Sik, a lawmaker from South Korea’s Grand National Party, submitted a bill to parliament last week to revive a 14 percent tax on foreigners’ bond holdings and financial regulators are examining banks to ensure they meet currency derivative caps announced in June.

Government Bonds

South Korea’s benchmark interest rate isn’t yet at a neutral level and the economy isn’t ready for “normal” rates yet, Kim said after the interest-rate decision.

“It was a positive day for bonds because the central bank’s signal of additional rate increases was weak,” said Peter Park, a fixed-income analyst at Woori Investment & Securities Co in Seoul. “The foreigner bond tax is already priced in too. We expect the next rate hike to be in the first quarter of next year.”

The yield on the 3.75 percent note due June 2013 fell 16 basis points to 3.32 percent, the most in a month, according to Korea Stock Exchange.

-- With assistance from Kyunghee Park in Seoul. Editors: Simon Harvey, Brett Miller

To contact the reporter on this story: Frances Yoon in Seoul at fyoon2@bloomberg.net Kyunghee Park at kpark3@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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