Bank of Korea May Keep Rate at 5% as Economy Slows

By William Sim

Aug. 6 (Bloomberg) -- The Bank of Korea may keep interest rates unchanged tomorrow after the economy grew at the slowest pace in more than a year and oil retreated to a three-month low.

Governor Lee Seong Tae and his six colleagues will leave the seven-day repurchase rate at a seven-year high of 5 percent tomorrow, according to 13 of 19 economists surveyed by Bloomberg News. Six expect a quarter-point increase.

Lee must balance signs of a slowdown in domestic demand against his objective of controlling inflation that is running at the fastest pace in a decade. Ssangyong Motor Co. and Hyundai Motor Co. are among companies that have reported declining sales as Korean consumers rein in discretionary spending because of a surge in fuel and food costs.

``The central bank still faces a big dilemma between growth and inflation,'' said Lee Sang Jae, an economist at Hyundai Securities Co. in Seoul. ``A rate hike seems unlikely this year as oil prices fall and domestic demand weakens.''

Oil has lost more than $28 since touching a record of $147.27 a barrel in New York on July 11.

The Federal Reserve yesterday kept its benchmark rate at 2 percent and signaled that weak employment and financial instability will delay any increase in borrowing costs. The European Central Bank and Bank of England, also beset by faster inflation and slower growth, are forecast by economists to stand pat this week.

The won rose 0.2 percent to 1,016.10 won versus the dollar at 9:30 a.m. in Seoul. The five-year government bond yield declined 5 basis points to 5.75 percent. The Kospi stock index climbed 2.2 percent to 1,568.66.

Economy Weakens

South Korea's economy grew 4.8 percent last quarter from a year earlier, the weakest pace in more than a year. Spending by households, which are burdened with record debt, fell 0.1 percent in the quarter, the first decline in four years.

Reports since the Bank of Korea's July meeting have provided more evidence of a slowdown. Households were at their most pessimistic in almost four years in June and manufacturers' confidence for August sank to the lowest in three years.

Factory output advanced 6.7 percent in June from a year earlier, the smallest gain in nine months. A leading index of economic indicators, a gauge of future business activity, rose 1.2 percent, the least in five years.

Ssangyong Motor, the South Korean unit of China's biggest automaker, reported that domestic sales slumped 67 percent in June from a year earlier. Local sales at Hyundai Motor, the nation's largest car producer, slipped 0.6 percent in the second quarter.

Increase Expected

Still, six of the 19 economists surveyed expect the Bank of Korea to raise interest rates tomorrow to keep inflation expectations in check.

Consumer prices in South Korea surged 5.9 percent in July from a year earlier. That was the ninth consecutive breach of the central bank's target of keeping inflation between 2.5 percent and 3.5 percent, on average, for the three years to 2009.

Policy makers in India, Indonesia, Taiwan, the Philippines and Thailand have all raised interest rates this year even as the Asian region faces fallout from a global slowdown.

``We expect one token rate hike in August as a reaction to the massive inflation pressure in July,'' said Chun Chong Woo, an economist at SC First Bank Korea Ltd. in Seoul. ``A further rate hike is unlikely as downside risks to the economy will be more severe going forward.''

Shipments to China, the Middle East and Latin America, buoyed in part by a weaker won, have helped South Korea weather the domestic slowdown and a U.S. economic slump. Exports surged 37.1 percent in July from a year earlier, the most in four years.

The won has fallen 8 percent this year against the dollar, helping Korea's exporters by making their products cheaper overseas.

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

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                                  August    2nd-Half  1st-Half
                                   2008      2008      2009
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Median Forecast                    5.00%     5.25%     5.25%
% forecasts at Median                68%       37%       26%
High                               5.25%     5.50%     5.75%
Low                                5.00%     5.00%     4.25%
Forecasts                            19        19        19
-------------------------------------------------------------
Action Economics                   5.25%     5.50%     5.50%
Citibank                           5.00%     5.25%     5.25%
Credit Suisse                      5.00%     5.25%     5.25%
Daewoo Securities                  5.25%     5.25%     4.75%
DBS Group                          5.00%     5.00%     5.00%
Forecast Singapore Ltd.            5.00%     5.00%     4.25%
Good Morning Shinhan Securities    5.00%     5.00%     5.00%
Hana Daetoo Securities             5.00%     5.25%     5.25%
HSBC                               5.00%     5.00%     5.25%
Hyundai Securities                 5.00%     5.00%     4.50%
JPMorgan Chase                     5.00%     5.00%     5.25%
Lehman Brothers                    5.25%     5.25%     5.00%
Samsung Economic Research          5.00%     5.00%     5.00%
Samsung Securities                 5.25%     5.50%     5.50%
SC First Bank Korea                5.25%     5.25%     4.75%
Shinhan Bank                       5.00%     5.25%     5.00%
Taurus Investment Securities       5.00%     5.50%     5.50%
Thomson Reuters                    5.25%     5.50%     5.50%
Woori Investment & Securities      5.00%     5.50%     5.50%
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To contact the reporter on this story: William Sim in Seoul at wsim2@bloomberg.net