Bank of Korea Holds Key Rate as Inflation Accelerates

By William Sim

July 10 (Bloomberg) -- The Bank of Korea kept interest rates unchanged at the highest level in seven years, saying it expects inflation to accelerate and economic growth to cool.

Governor Lee Seong Tae and his colleagues left the seven-day repurchase rate at 5 percent in Seoul today, as forecast by all but two of 21 economists surveyed by Bloomberg News. They last adjusted the rate in August with a quarter-point increase.

Record fuel prices and a weaker won are driving the fastest inflation in almost 10 years, which in turn is taking its toll on consumers and businesses. A 5 percent gain in the won this week after a government pledge to take stern measures to halt its drop may have eased pressure on the central bank to raise rates.

``It seems clear the government is trying to cool inflation by supporting a stronger won,'' said Lim Ji Won, an economist at JPMorgan Chase & Co. in Seoul. ``The government is helping the central bank by giving it more time to resolve the dilemma between growth and inflation.''

The yield on the five-year government bond fell one basis point to 6.05 percent as of 12:40 p.m.

Consumer prices jumped 5.5 percent in June from a year earlier, breaching the central bank's target range for an eighth straight month. The bank aims to keep inflation between 2.5 percent and 3.5 percent, on average, for the three years to 2009.

``It would be difficult for inflation to fall back quickly to about 3 percent next year,'' Lee said in Seoul after the decision. ``We are concerned about the so-called secondary effect that inflationary expectations will rise further and put pressure on wages to climb.''

Won's Gain

The won gained 0.6 percent to 998.5 won against the dollar at 12:40 p.m., leaving it down 6.6 percent for the year. The currency dropped as much as 11 percent against the dollar this year, reaching a closing low for 2008 on July 4.

The government this week indicated it backs a stronger won, saying it would take ``stern action'' on the currency's decline.

The Bank of Korea has probably spent more than $12 billion since the end of May to boost the value of the currency, said Jung Chan Ho, a currency dealer at Shinhan Bank in Seoul.

``The government has repeatedly expressed concerns about inflation and vowed to focus on controlling prices,'' said Oh Suk Tae, economist at Citibank Korea Inc. in Seoul. ``It's about time the central bank takes some policy response to contain inflation, otherwise, it will be too late.''

The Bank of Korea on July 1 raised its 2008 inflation forecast to 4.8 percent from December's prediction of 3.3 percent. Economic growth will slow to 4.6 percent this year from 5 percent in 2007, it forecast.

Export Growth

Export growth is likely to accelerate this month from June because of rising demand from emerging markets and a weaker currency, the Ministry of Strategy and Finance said today.

Asia-Pacific central banks are battling to balance the fallout from slowing economic growth against a pickup in inflation. Central banks in Indonesia, India and Taiwan all raised borrowing costs in the past month.

President Lee Myung Bak has shifted his priority to fighting inflation from spurring economic growth as his popularity slumps amid public anger over soaring living costs and his decision to lift a ban on U.S. beef imports.

South Korea's economy expanded at the slowest pace in more than a year in the first quarter from the previous three months as consumers and businesses cut spending. The latest data suggest growth will slow further.

Industrial production rose the least in six months in May. Exports, which powered almost all of the economy's first-quarter expansion, had the smallest gain in five months in June.

Hyundai Motor Co., South Korea's biggest carmaker, on July 6 lowered its 2008 domestic sales target by 6 percent as rising oil costs and a weakening economy damp demand.

To contact the reporter on this story: William Sim in Seoul at wsim2@bloomberg.net.