SKorean central bank raises rate to 2.5 percent

[November 16, 2010]  SEOUL, South Korea (AP) -- South Korea raised its key interest rate Tuesday for the second time in four months as higher inflation forces Asian central banks to increase borrowing costs.

The Bank of Korea lifted the benchmark seven-day repurchase rate to 2.5 percent from 2.25 percent at a monthly monetary policy meeting after inflation hit 4.1 percent in October.

The bank also removed the wording "under the accommodative policy stance" from its statement, suggesting that interest rates will continue to rise to more normal levels after two years of super-low borrowing costs.

Asian countries are under increased pressure to contain inflation after their economies rebounded strongly from the global recession and as food prices surge.

China raised its key rate last month for the first time since 2007 and expectations of further rate hikes were kindled after figures last week showed inflation at a 25-month high in October. India's central bank earlier this month raised rates for the sixth time this year to contain persistently high price rises.

Underscoring Beijing's concern about double-digit increases in food costs, the Commerce Ministry on Tuesday released stockpiled pork and sugar in an attempt to increase supplies of staples to cool prices.

The Bank of Korea's rate hike and jitters that China will take new steps to cool its economy, the world's second-largest, sent stock markets lower across Asia and Europe. China's Shanghai Composite Index tumbled 4 percent.

South Korea's year-on-year increase in consumer prices was slightly outside the central bank's comfort zone for inflation. The bank's inflation target is 3 percent, though that includes what it calls a "tolerance range" of plus or minus 1 percentage point.

The increase in inflation was mainly driven by higher prices for farm produce, the central bank's policy committee said in the statement.

"Upward pressures are expected to continue" in line with strength in the domestic economy and increased international raw material costs despite some respite expected from stabilizing vegetable prices, said the committee, which is chaired by BOK Gov. Kim Choong-soo.

The Bank of Korea slashed its interest rate a total of 3.25 percentage points to a record low 2 percent between October 2008 and February 2009, joining other central banks in combating the effects of the global financial crisis and economic downturn that followed. It raised the borrowing cost to 2.25 percent in July amid solid growth prospects for the domestic economy and budding inflation worries.

Tuesday's decision was widely expected. A total of 11 economists at 13 financial institutions surveyed by Yonhap Infomax, the financial news arm of Yonhap news agency, predicted the bank would increase the rate to 2.5 percent.

The bank cited the possibility of increased economic volatility and exchange rate movements in "major countries" as international risk factors, though was largely upbeat on the outlook for South Korea.

The bank did not elaborate on the currency risks but international attention has recently focused on Washington's criticism that Beijing keeps its currency, the yuan, artificially weak to gain a trade advantage.

There are concerns that the spat over how to reduce U.S. trade deficits with countries like China, Japan and Germany could resurrect destructive protectionist policies and hurt emerging countries such as South Korea.

South Korea's economic expansion has moderated recently. Growth in the three months ended Sept. 30 slowed to 0.7 percent from 1.4 percent in the previous three months. It was the second straight quarter of slower growth in Asia's fourth-largest economy.

"The domestic economy is expected to continue on an underlying upward track, even in the presence of external risk," the statement said.

Kwon Goohoon, economist at Goldman Sachs in Seoul, said the different wording in the central bank's statement was an "important change" that signals more rate hikes are possible if outside risks diminish.

"Policymakers are keen to avoid the need for a sharp tightening when and if the global recovery takes hold and inflation pressure escalates," he wrote in a report. Another quarter-point rate increase is expected in February, he said.

Hikes will likely total three quarters of a percentage point next year, he said, meaning the rate would reach 3.25 percent at the end of 2011.

[Associated Press; By KELLY OLSEN]

Associated Press writer Chi-Chi Zhang in Beijing contributed to this report.

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