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(LEAD) BOK unexpectedly hikes key interest rate to 2.25 pct

All Headlines 11:19 July 09, 2010

(ATTN: RECASTS headline, first 2 paras; ADDS more details, statement by BOK in paras 5-7,11; TRIMS throughout)
By Kim Soo-yeon

SEOUL, July 9 (Yonhap) -- South Korea's central bank Friday conducted a surprise rate hike for July on concerns that the fast recovery of the local economy will likely put upward pressure on inflation.

Bank of Korea (BOK) Gov. Kim Choong-soo and other policymakers hiked the benchmark seven-day repo rate to 2.25 percent from a record low of 2 percent, the first increase since August 2008. The July decision marked the first rate hike since the global financial turmoil.

The decision was out of line with a median forecast by Yonhap Infomax, the financial news arm of Yonhap News Agency. Only two economists at 13 financial institutions forecast a rate hike for July.

The BOK froze the key rate for the 16th straight month in June, the longest stand-pat run, after cutting 3.25 percentage points between October 2008 and February 2009 in an effort to boost the slumping economy.

"The upward trend of the economic activity will continue to increase upward pressure on inflation," the BOK said in a statement.

The BOK said it will manage its monetary policy in a way that the economy can keep its solid growth on the basis of price stability.

"A rate hike came in a bid to stem inflationary pressure. The BOK is likely to check the impacts of the rate increase by checking economic conditions at home and abroad and raise the borrowing costs to 3 percent by the third quarter of next year," said Lee Sung-kwon, an economist at Shinhan Investment Corp.

The need to normalize the exceptionally low rate is increasing as the Korean economy is recovering at a faster pace, but many experts anticipated that the central bank may conduct its first rate increase as early as August.

Last month, Gov. Kim warned that the long streak of low rates has risks of sparking inflation and an asset bubble, signaling that a rate hike is not far off.

The Korean economy, Asia's fourth-largest, chalked up a surprise 2.1 percent on-quarter expansion in the first quarter, underscoring the strong economic fundamentals. Amid the recovery, a recent pickup in the country's producer and import prices pointed to a buildup in inflationary pressure down the road.

Kim said that actual economic growth is likely to exceed potential output in the second half, indicating that inflationary pressure would mount down the road.

The government said it will "normalize" stimulus measures introduced to fight the global financial turmoil by closely watching inflation, employment and financial market conditions, a turnaround from its previous stance that it will keep accommodative policy measures for the time being.

In late June, the government revised up its 2010 growth forecast to 5.8 percent from its earlier prediction of 5 percent. The central bank's current forecast stands at 5.2 percent.

Economists said the central bank will continue to raise the cost of borrowing in a piecemeal fashion within this year, but a steep rate hike is not likely to come as economic uncertainty, including Europe's debt problems, linger and the momentum of the economic recovery may weaken in the second half.


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