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(News Focus) Rate hike heralds start of Korea's stimulus exit

All Headlines 16:48 July 09, 2010

By Kim Soo-yeon

SEOUL, July 9 (Yonhap) -- The blitzkrieg interest rate hike by South Korea's central bank can be seen as a sign that the country has begun to roll back its measures to cushion Asia's fourth-largest economy against the fallout of the global financial turmoil, analysts said Friday.

Beating market forecasts, the Bank of Korea (BOK) raised the benchmark seven-day repo rate to 2.25 percent from a record low of 2 percent earlier in the day, ending the 16th straight month of stand-pat run, as the fast recovery of the local economy will likely put upward pressure on inflation.

"Now is an appropriate timing for a rate hike, given inflationary pressure and other economic conditions," BOK Gov. Kim Choong-soo told a press conference after the monthly rate-setting session.

As the South Korean economy is on a solid recovery path despite renewed concerns about the flagging global economy, risks of higher inflation are looming large, he said.

Gov. Kim has warned that the long streak of low rates can pose risks of sparking inflation and an asset bubble, adding that the country's actual economic growth is likely to exceed potential output in the second half, indicating mounting inflationary pressure.

The BOK had aggressively cut the key rate by a total of 3.25 percentage points till February 2009 in an effort to boost the slumping economy.

According to the BOK, the local economy grew over 1 percent on-quarter in the second quarter after expanding 2.1 percent three months earlier. Consumer inflation is expected to top 3 percent next year.

Market watchers said the rate increase shows that the central bank is ending its accommodative monetary policy as the economy is picking up faster than expected.

"The rate hike is seen as the start of the normalizing process," said Gong Dong-rak, a fixed-income analyst at Taurus Investment & Securities Co.

South Korea has already withdrawn some emergency measures taken to fight the global financial storm -- calling in foreign currency liquidity provided to the market and cutting a cap on its soft loans for smaller firms. The card of a rate hike was the key option left for the central bank.

Think tanks and overseas organizations, including the International Monetary Fund, have called for the raising of borrowing costs.

The IMF recently said that South Korea needs to push for "a carefully calibrated exit" from its economy-boosting emergency measures, calling for a gradual rate hike.

Analysts said the BOK is expected to hike the rate further within this year, but the pace would not be fast because it would want to check the development of the eurozone debt problems and other economic uncertainties.

Gov. Kim said after the rate-setting meeting that a quarter percentage point hike does not mean an end to an accommodative stance and the central bank will give proper signals before conducting a rate hike down the road, signaling that an additional rate hike is in its cards.

"The trend of a rate hike will continue, but it may take time for the key rate to return to the neutral level," said Lim Ji-won, an economist at JP Morgan. "If the global economic conditions do not become worse, the BOK will likely hike the rate two or three times gradually."

June Park, an economist at Woori Investment & Securities Co., said the key rate is likely to rise to up to 2.75 percent by the end of this year, adding that even if the BOK hikes the rate to 3 percent, its pace is not seen as aggressive, given the strength of the local economy.


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