Bank of Korea Raises Rate to 5.25% to Curb Inflation

By William Sim

Aug. 7 (Bloomberg) -- The Bank of Korea raised its benchmark interest rate by a quarter point to the highest in almost eight years, judging the fastest inflation in a decade is a greater threat than slowing economic growth.

Governor Lee Seong Tae increased the seven-day repurchase rate to 5.25 percent in Seoul today, as forecast by just six of 19 economists surveyed by Bloomberg News. The rest predicted no adjustment.

Lee joins policy makers in India, Indonesia, Taiwan, Thailand and the Philippines in boosting borrowing costs this year to rein in accelerating inflation caused by a surge in food and fuel costs. Spiraling prices have sapped Korean consumers' purchasing power and squeezed corporate profits, leading to a slowdown in Asia's fourth-largest economy.

``A rate hike is necessary to keep inflation expectations in check,'' said Kim Seon Tae, an economist at Shinhan Bank in Seoul. ``A further increase seems unlikely as downside risks to the economy are mounting.''

The Kospi index of stocks fell 0.7 percent to 1,568.02 at 10:08 a.m. in Seoul. The won rose 0.03 percent to 1,015.55 against the dollar.

Consumer prices climbed 5.9 percent in July from a year earlier, exceeding the central bank's target for the ninth straight month. The bank aims to keep inflation between 2.5 percent and 3.5 percent, on average, for the three years to 2009.

Not Needed

Some economists said a rate increase is not needed because of mounting evidence the economy is cooling and as oil prices retreat from a record.

``A rate hike would do more harm than good to the economy now,'' Lim Ji Won, senior economist at JPMorgan Chase & Co. in Seoul, said before today's decision. ``Inflation will probably peak this quarter amid a global economic slowdown.''

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

Ssangyong Motor Co., 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 Co., Korea's largest carmaker, slipped 0.6 percent in the second quarter.

The economy expanded 4.8 percent last quarter from a year earlier, the weakest pace since the first three months of 2007. Spending by households, which are burdened with record debt, fell 0.1 percent in the quarter, the first decline in four years.

Growth, Inflation

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 increased 6.7 percent in June from a year earlier, the smallest gain in nine months.

President Lee Myung Bak has shifted his priority to stabilizing prices from spurring economic growth as his popularity slumps amid public anger over soaring living costs.

The nation's inflation problem has been exacerbated by this year's 8 percent drop in Korea's won against the dollar, which makes imported goods more expensive. Import prices surged 49 percent in June from a year earlier, the biggest gain in more than 10 years.

The central bank is estimated to have spent more than $12 billion since the end of May to boost the value of the won and cool inflation, said Jung Chan Ho, a currency dealer at Shinhan Bank in Seoul.

President Lee dismissed Vice Finance Minister Choi Joong Kyung, who was in charge of the government's foreign-exchange policy, in a Cabinet reshuffle last month.

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