South Korea Cuts Rate to 4% to Stave off Recession

By William Sim

Nov. 7 (Bloomberg) -- The Bank of Korea lowered interest rates for the third time in four weeks and signaled it's ready to act again to prevent the economy from sinking into the first recession in a decade. The nation's shares and currency rose.

The bank reduced the key rate by 25 basis points to 4 percent, the lowest since 2006, adding to 100 basis points of cuts in October. Policy makers are focused on keeping ``the economy from weakening too much,'' Governor Lee Seong Tae said, adding he's prepared to ``take bigger actions if necessary.''

Lee has undertaken the most aggressive round of cuts since the bank began setting a policy rate a decade ago, striving to limit economic damage from the global credit crisis that has sent Korea's won down 30 percent this year and the stock index plunging 41 percent. India, Japan and Australia lowered rates in the past week as the financial turmoil that has pummeled the U.S. and Europe threatens to engulf Asia's export-dependent economies.

``The Bank of Korea is joining global efforts to prevent a recession and can't afford to be an outsider,'' said Park Sang Hyun, an economist at HI Investment & Securities Co. in Seoul.

The Bank of England slashed its benchmark rate by 1.5 percentage points yesterday and the European Central Bank lowered its rate by a half-point. The International Monetary Fund yesterday predicted economic contractions in the U.S., Japan and euro region next year, calling for further interest- rate cuts and fiscal stimulus.

Further Reductions

Twelve of 16 analysts surveyed by Bloomberg expected Korea to cut borrowing costs today. Economists from Capital Economics Ltd. and SC First Bank Ltd. forecast the benchmark rate will be reduce to 2 percent by mid-2009 as the economy falters.

``The committee will do what's needed to ward off the risk of a severe slowdown in economic activity brought about mainly by financial-market unrest,'' the Bank of Korea said today, adding inflation pressures are moderating.

The Kospi stock index rose 3.9 percent to 1,134.49 at the close of trading in Seoul. The won climbed 0.2 percent to 1,328.7 per dollar.

``The central bank probably will cut rates further because, like other countries, Korea is clearly under a lot of pressure going through this financial turmoil,'' said David Cohen, director of Asian forecasting at Action Economics in Singapore. That said, South Korea has been ``very aggressive'' in taking steps to aid its economy compared with Asian neighbors, he added.

Liquidity Measures

South Korea has pumped funds into the banking system, guaranteed lenders' debts and secured an Oct. 30 agreement from the Federal Reserve to provide $30 billion in U.S. currency as the nation tackles its biggest crisis since needing an IMF bailout in 1997.

The measures are aimed at easing the freeze in credit markets and a shortage of U.S. dollars that has stoked concern the nation's banks wouldn't be able to refinance their offshore borrowing.

Korea's won rebounded after the Fed swap deal was announced from the lowest level in 10 years and default protection costs on government debt fell by the most in more than four years.

``Concerns about foreign-currency liquidity seem to have mostly diminished and now is the time to take more close care of the real economy,'' President Lee Myung Bak said this week.

Finance Minister Kang Man Soo unveiled a 14 trillion won ($10.5 billion) package of extra spending and corporate tax breaks this week, adding to almost $20 billion in income-tax reductions announced in September.

Slowdown Deepens

South Korea's slowdown is deepening. Economic growth cooled to the weakest in four years last quarter as exports declined the most in almost seven years and consumer spending stagnated.

Exports, the main engine of the economy's expansion, rose at the weakest pace in 13 months in October as shipments to China, South Korea's biggest market, fell for the first time since 2002. Retail sales gained by the least in nine months in September.

Hyundai Motor Co., South Korea's second-biggest exporter, on Oct. 23 slashed its global vehicle-sales forecast for the year. Posco, the region's biggest maker of stainless steel, said last month it will cut output by about a third this quarter to cope with slowing demand.

``The central bank probably didn't cut rates more than 25 basis points today because more reductions are on the way,'' said Lee Sang Jae, an economist at Hyundai Securities Co. in Seoul. ``You don't want to use up all your bullets at once.''

Consumer prices rose 4.8 percent in October, the smallest gain in six months. Inflation peaked at 5.9 percent in July.

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