South Korea Unexpectedly Keeps Rate at Record-Low 2%

By Seyoon Kim

March 12 (Bloomberg) -- The Bank of Korea unexpectedly kept its interest rate unchanged at a record-low 2 percent today, ending the nation’s most aggressive policy easing in a decade.

“We have lowered the benchmark interest rate at a rapid pace in a short period,” Governor Lee Seong Tae said in Seoul. “We’ll be monitoring the effects of the previous steps.”

South Korea’s currency and shares declined after the central bank said the economy is likely to remain in a recession amid “persistent weakness” in local and overseas demand. Lee has pared rates by 3.25 percentage points since Oct. 9 and Finance Minister Yoon Jeung Hyun plans to unveil an additional stimulus package this month to add to 51 trillion won ($34.7 billion) in tax cuts, handouts and infrastructure spending.

“They’ve cut very aggressively and are now taking a breather, but it is hardly a response to any better data,” said Jan Lambregts, head of Asian research at Rabobank International in Hong Kong. “I expect in the months to come that they will pick it up again. Many Asian central banks are going to cut rates close to zero percent.”

Just three of 15 economists surveyed by Bloomberg expected today’s decision with the remainder predicting a cut. The six reductions since early October are the most aggressive easing since the Bank of Korea began setting a policy rate a decade ago.

The Kospi stock index fell 1.5 percent to 1,111.01 after the decision, snapping three days of gains and increasing its loss over the past year to 33 percent. Korea’s won dropped 1.1 percent to 1,486.7 per dollar as of 1:18 p.m. in Seoul after last week reaching an 11-year low of 1,597.

Tumbling Currency

“The Bank of Korea probably felt pressure to keep rates unchanged as lower interest rates can prompt investors to take more money out of the country, weakening the won further,” said David Kim, head of research at Taurus Investment Securities Co. in Seoul.

A falling won, Asia’s worst-performing currency in 2009, increases the cost of financing offshore loans for Korean companies and could fan inflation by pushing up import prices.

South Korea’s pause in easing follows the Reserve Bank of Australia, which last week left its rate unchanged for the first time in seven months. New Zealand central bank Governor Alan Bollard said today he would reduce the pace of rate cuts in future after 5.25 percentage points of easing since July.

Government Spending

South Korea’s government said today it will provide cash, loans, school fees and other financial incentives valued at 6 trillion won to help those on lower incomes cope with rising unemployment. The aid package will use funds from the extra budget being proposed this month, the finance ministry said.

Bank of Korea Governor Lee said he expects the government to propose “a significant” extra spending package, financed through bond sales. The central bank will watch the effect of debt sales on financial markets as it decides whether to purchase bonds, he added.

“The Korean economy is likely to remain in recession due to the persistent weakness of both domestic and overseas demand,” the central bank said today.

The World Bank this week forecast the global economy will shrink in 2009 for the first time since World War II and that trade will fall by the most in eight decades.

Exports of cars, ships, mobile phones and other goods, which make up more than 60 percent of South Korea’s gross domestic product, fell 17.1 percent in February.

Bank Aid

As well as boosting spending, South Korea has been widening efforts to aid banks by injecting $39 billion into the financial system to thaw credit markets, setting up a 20 trillion won fund to replenish bank capital as bad loans increase, and establishing another fund to buy distressed corporate bonds.

Bank profits almost halved last year on provisions for loans to struggling developers and shipbuilders. Kookmin Bank, the nation’s largest lender, posted its first loss in four years in the fourth quarter.

“Both the central bank and the government should continue to do what they can to help the economy,” said Ryu Seung Sun, an economist at HMC Investment Securities Co. in Seoul. “There are global efforts to prop up economies. South Korea shouldn’t exclude itself from the moves.”

Asia’s fourth-largest economy contracted 3.4 percent last quarter, the first decline in 11 years, as exports to the U.S., Europe and China dropped. Goldman Sachs Group Inc. this week forecast the economy will shrink 4.5 percent in 2009.

South Korea lost 103,000 jobs in January, the biggest decline since September 2003. Genworth Financial Inc. announced last month the closure of its South Korean business as it cuts costs globally. Industrial production plunged a record 25.6 percent in January.

LG Electronics Inc., the world’s third-largest maker of mobile phones, says industry shipments will fall more than previously expected in 2009. Hyundai Heavy Industries Co., the world’s largest shipbuilder, said last month that orders dropped 54 percent in January from a year earlier.

To contact the reporter on this story: Seyoon Kim in Seoul at Skim7@bloomberg.net