Bank of Korea Raises Benchmark Interest Rate to 3.25% to Tame Inflation
Governor Kim Choong Soo boosted the benchmark seven-day repurchase rate to 3.25 percent from 3 percent, following quarter-percent increases in January and March, the central bank said in a statement in Seoul today. Kim said the decision was unanimous. Eight of 17 economists surveyed by Bloomberg News predicted the decision with the rest expecting no change.
South Korea joined Thailand in raising borrowing costs this month as job growth and costlier energy caused consumer-price gains to exceed the Bank of Korea’s 4 percent ceiling every month this year. The yield on five-year government bonds rose 12 basis points to 3.95 percent, the highest since May 20, as Kim said he must stop inflation from becoming a “chronic problem.”
“It was a sensible move by the BOK, in recognition that the balance of risks are still clearly tilted towards inflation,” said Wai Ho Leong, a senior regional economist at Barclays Capital in Singapore. “The bank remains on a consistent normalization path” and will raise rates again in September, he said.
The won rose 0.03 percent to 1,082.65 per dollar as of the 3 p.m. close in Seoul, extending the currency’s advance this year to 4 percent. The Kospi stock index fell 1.2 percent, erasing earlier gains of as much as 1.1 percent.
Bank Indonesia left its reference rate at 6.75 percent yesterday as a strengthening currency helped contain inflation. Thailand raised rates for a fourth time this year while the Philippine central bank increased the rate it pays lenders for overnight deposits to 4.5 percent in May.
The Korean central bank signaled that it will continue to raise rates because of persistent price pressures, a departure from some central banks in Asia that have paused on tightening as oil prices retreat from their April peak and higher borrowing costs cool growth.
“The committee will conduct monetary policy with a greater emphasis on ensuring that the basis for price stability is firmly anchored while the economy continues its sound growth,” the BOK said in a statement. “Despite the temporary sluggishness of domestic demand, the economy has maintained its underlying upward trend.”
Higher rates may fuel gains in the won, eroding export sales that are a key driver of the economy. Overseas shipments climbed 23.5 percent in May from a year earlier, less than economists expected, after reaching a record in April.
‘War’ on Inflation
President Lee Myung Bak declared “war” on inflation in January, and the government imposed price controls and tolerated currency appreciation as part of the campaign, as the rising cost of living contributed to growing public discontent. His approval rating fell to 28.4 percent in a May 30-June 3 poll compared with 76 percent when he came to power in February 2008, according to Seoul-based Realmeter.
Consumer prices rose 4.1 percent in May from a year earlier, the fifth-straight month it exceeded the central bank’s target of 2 percent to 4 percent through 2012. Core inflation excluding volatile food and energy items accelerated to a two-year high of 3.5 percent in May. Producer prices increased 6.2 percent in May, the slowest pace in four months, a report today showed.
The central bank has raised interest rate from a record-low 2 percent since early July as it expects consumer prices to rise 3.9 percent this year, near its 4 percent inflation target limit, while the economy will grow 4.5 percent.
Complicating efforts to fight inflation, household debt rose to a record 801.4 trillion won ($740 billion) in the first three months of this year, the Bank of Korea said on May 25. A separate report showed yesterday that the nation’s bank lending to households rose the most in six months to another record 439.8 trillion won in May. Consumer borrowing has helped fuel housing demand and consumption, supporting growth.
Interest rates are still “significantly below the growth rate,” an incentive for indebted households to borrow more, according to Erik Lueth, a Hong-Kong based economist at Royal Bank of Scotland Group Plc. With core inflation continuing to rise “monetary conditions are still accommodative,” he said.
Financial liabilities of individuals in South Korea were 155.4 percent of disposable income at the end of 2010, “one of the highest ratios globally” and is still climbing, Young Il Choi, an analyst at Moody’s Investors Service, said in a report last month. The Financial Services Commission said this week authorities need to pay special attention to household debt, “which may weigh considerably on the financial market.”
Not Beyond Control
“The household debt is far from small but it’s not beyond our control,” Governor Kim said at a press conference today. “We need to address it first with microeconomic policy tools and also consider the appropriate level of liquidity for the nation on the macroeconomic and monetary policy front.”
The Finance Ministry said in its monthly economic assessment report yesterday that external conditions are “highly uncertain” due to high oil prices, a possible slowdown in major economies and renewed concerns over the European fiscal crisis.
LG Electronics Inc. (066570), the world’s third-largest mobile-phone maker, said last week that a recovery at its handset business may take longer than some analysts expected. LG’s mobile-phone division had an operating loss of 100.5 billion won ($93 million) in the first three months of the year, contributing to a second straight quarterly loss for the company.
South Korea’s economy grew 4.2 percent in the first quarter from a year earlier, unchanged from an earlier estimate, the central bank said this week. The economy expanded 1.3 percent in the three months through March from the previous quarter, less than the April estimate of a 1.4 percent gain, mainly due to weak private consumption and facility investment.
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