Bank of Korea May Keep Rate at 7-Year High on Inflation Concern

By William Sim

July 9 (Bloomberg) -- The Bank of Korea will probably hold interest rates at a seven-year high this week after signs the economy cooled and inflation accelerated.

Governor Lee Seong Tae and his six colleagues will leave the seven-day repurchase rate at 5 percent tomorrow, according to all but two of 21 economists surveyed by Bloomberg News. They last adjusted the rate with a quarter-point increase in August.

Record fuel prices, coupled with a weaker won, are fueling the fastest inflation in almost 10 years, putting pressure on the central bank to raise borrowing costs. Still, policy makers are concerned Asia's fourth-largest economy will cool further as domestic demand falters and export growth slows.

``It's still a big dilemma for the central bank to raise or cut interest rates,'' said Kwon Young Sun, an economist at Lehman Brothers Inc. in Hong Kong. Kwon expects the bank to keep rates on hold for the rest of the year because of the ``balanced risks of inflation and economic growth.''

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.

The Bank of Korea last week 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.

Economic Growth

South Korea's $970 billion economy expanded at the slowest pace in more than a year in the first quarter as consumers and businesses cut spending. The latest data suggest growth will cool 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.

Shipments to China, the Middle East and Latin America, buoyed in part by a weaker won, have helped South Korea weather a slowdown in domestic demand and a slump in the U.S. economy.

Business and consumer confidence is also declining as oil costs, which doubled in the past year, erode household incomes and squeeze corporate profits. South Korea imports 97 percent of its energy.

South Korean households, also weighed down by record debt, were the most pessimistic in more than seven years in the second quarter. Manufacturers' confidence for July fell to the lowest level in more than three years.

Inflation Rate

Inflation has also been fanned by this year's 9.5 percent drop in the won, which increases import costs.

President Lee Myung Bak on July 7 dismissed Vice Finance Minister Choi Joong Kyung, who was in charge of the government's foreign-exchange policy, in a Cabinet reshuffle.

The Bank of Korea has possibly spent more than $10 billion since the end of May to boost the value of the nation's currency and cool inflation, said Jung Chan Ho, a currency dealer at Shinhan Bank in Seoul.

The president 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.

The focus of policy makers may shift back to supporting growth should oil prices subside and inflation begin to cool.

``We expect the central bank to keep rates on hold this year and cut them by 75 basis points in the first half next year,'' Kwon said.

The following table shows forecasts for the July 10 decision, which is expected before 11 a.m. in Seoul, and for rates by the second half of this year and the first half of 2009.

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