SEOUL (Thomson Financial) - The Bank of Korea on Thursday raised its benchmark call rate target by 25 basis points to a six-year high of 4.75 percent, the first increase in nearly a year, in a bid to mop up excess liquidity which it fears could feed on inflation.
The BoK's strong view of the economy as well as comments made by its governor Lee Seong-Tae, seen as hawkish, have prompted speculations that another rate hike could be in the offing in the coming months.
Prior to the increase, the central bank had kept the call rate target at 4.5 percent for the past 10 consecutive months, after hiking it by a cumulative 125 basis point on five occasions between October 2005 and August 2006.
The current level is the highest since July 2001.
"Governor Lee's comments on inflation seem to have signalled another rate hike," Goodmorning Shinhan Securities analyst Lee Sung-Kwon said.
Shinhan's Lee had previously expected the BoK to stand pat on rates in July.
But he now expects the central bank to raise the call rate by another notch to 5.00 percent, possibly in October ahead of the presidential election at year-end.
Lee however said the bank will find it difficult to hike the target above 5.00 percent as the US Federal Reserve is likely to keep their rates on hold for the time being, and in order to stem the won's strength against the US dollar.
The US key rate is currently at 5.25 percent.
Chun Jong-Woo, a senior economist at SC Firstbank, a local unit of Standard Chartered, said governor Lee's stance that the current call rate target is "not so high as to dampen economic recovery" signals another rate hike. Chun previously had voted for a rate hike in July.
But he said further rate hike action will likely come in the first and fourth quarters of 2008, which will eventually lift the key rate to 5.25 percent.
The BoK will likely maintain status quo in between that time, while assessing local economic developments and future monetary policy decisions of the Bank of Japan, which today voted to keep its overnight call rate target unchanged at 0.50 percent for the sixth straight meeting.
The Korean rate hike today could further boost the won's value against the Japanese yen, leading to a weakening of Korean exporters' price competitiveness and thus, hurting their profits, SC Firstbank's Chun said.
The increase came as no surprise to the market as the central bank had repeatedly signalled that it is considering the move prior to its meeting.
The BoK noted that high levels of liquidity have persisted in the financial system even after a series of measures to soak them up.
"In the financial markets, money supply growth has steepened since the fourth quarter of last year amid a sharp increase in bank loans to SMEs (small and medium enterprises)," governor Lee said at the conclusion of the monetary policy meeting.
Central bank data as of end-May show that South Korea's outstanding aggregate liquidity totaled 1,913.5 trillion won, up 1.3 percent from the previous month.
Concerns about liquidity flowing into the stock market, creating the possibility of an asset price bubble, were understood to be a factor in today's decision, especially since the KOSPI index has gained over 30 percent so far this year, making it one of the best performing bourses in the region.
The BoK said it is concerned that inflationary pressures could build up in the economy towards the first half of next year as a result of high oil prices and a recovery in domestic private consumption.
The central bank meanwhile expects the country's economic recovery to pick up pace in the latter part of 2007 and into 2008.
"The domestic economy seems likely to maintain its upward trend. While exports continue to post robust growth, investment and private consumption are increasing steadily," it said in a statement.
However it said risks to its growth projection are sustained high oil prices and a sharper appreciation of the local currency.
Oil prices have been trending back up towards their all-time high in recent trade, while the won has gained around 1 percent against the US dollar so far this year, on top of the 8 percent appreciation last year.
The BoK on Tuesday upgraded its own GDP projection for 2007 to a growth of 4.5 percent from 4.4 percent seen earlier, citing robust exports and a modest uptick in domestic demand.
Today's rate hike however failed to dampen enthusiasm for stocks with the mainboard KOSPI index finishing up more than 1 percent to a fresh record of 1,909.75, while the won had strengthened to 918.30 to the US dollar from 919.20 in the previous session.
Following news of the rate hike, Kookmin Bank said it planned to raise its one-year time deposit rate by 0.25 percentage points, while Shinhan Bank said it planned a hike of up to 0.3 percentage points.
Commercial banks typically adjust their deposit rates prior to setting their lending rates in response to the central bank's policy tightening.
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