Bank of Korea keeps key interest at 2.75 percent

By KELLY OLSEN AP Business Writer

SEOUL, South Korea (AP) - South Korea's central bank left its key interest rate on hold Friday even as it stressed that inflation pressure, which sparked earlier rate hikes, shows no sign of waning. Stocks dropped as foreign investors led selling.

The Bank of Korea's monetary policy committee kept the base rate at 2.75 percent at a monthly meeting. The rate influences a variety of interest rates including those on overnight loans between financial institutions and more broadly on items such as mortgage and credit card debt.

The decision was closely watched with attention focused on whether the BOK would carry out two consecutive rate increases for the first time in more than three years in a bid to control rising prices. It unexpectedly raised the rate in January for the second time in three months.

South Korean financial markets reacted negatively. The benchmark stock index, initially higher after the decision, fell 1.6 percent to close at 1,977.19 - a two-month low - on selling led by foreign investors. The South Korean won, meanwhile, dropped 1 percent to 1,128.60 against the dollar.

Central banks have been raising borrowing costs in a bid to stem inflation. China's central bank raised interest rates Tuesday for the second time since late December to rein in rising prices as well sizzling economic growth. India, Indonesia, Brazil and Hungary are among nations where rates have been raised this year.

The Bank of England on Thursday, however, left its base interest rate at 0.5 percent despite increasing worries about stubbornly high inflation. The rate has been at a record low since March 2009 to stimulate the economy.

Experts had been split on the outcome of the Bank of Korea decision. A total of 11 economists at 19 financial institutions surveyed by Yonhap Infomax, the financial news arm of Yonhap news agency, predicted the bank would not raise the rate.

Price pressures have been growing in South Korea, Asia's fourth-largest economy, and the bank's monetary policy committee, led by Gov. Kim Choongsoo, highlighted that trend in its statement.

"Consumer price inflation in Korea has increased significantly, driven by the prices of petroleum products and farm produce," the statement said. The committee said it "expects high inflation expectations to continue and inflationary pressures to also persist as the economic upswing continues."

The central bank's inflation target is 3 percent, though that includes what it calls a "tolerance range" of plus or minus 1 percentage point. January's consumer price index jumped 4.1 percent from the same month last year, landing slightly outside that range. The central bank expects inflation to increase to 3.5 percent in 2011 from 2.9 percent last year.

Average South Koreans are growing more worried about rising prices. Consumer confidence fell last month amid expectations for further price increases, according to a BOK survey.

Han Beom-ho, an analyst at Shinhan Investment Corp. in Seoul, said the decline in shares came as foreign investors are growing anxious over inflation trends in emerging markets and amid expectations that the Bank of Korea will hike the interest rate next month.

Kwon Goohoon, economist at Goldman Sachs in Seoul, said the BOK was likely to increase it three more times in 2011 from March, which would take the base rate to 3.5 percent by the end of the year.

"The policy statement maintains a hawkish stance" and signals further tightening, he wrote in a comment on the decision.

South Korea's economy recovered strongly last year, growing 6.1 percent after a mere 0.2 percent expansion in 2009 during the global economic slump. Growth is expected to slow to 4.5 percent this year, according to the BOK. The South Korean government, meanwhile, says the economy could grow about 5 percent.

The BOK had slashed the base rate a total of 3.25 percentage points between October 2008 and February 2009 to a record low 2 percent as it joined other central banks in fighting the global financial crisis. It began unwinding from the ultra-loose monetary policy in July last year when it lifted the rate to 2.25 percent amid solid growth prospects and budding inflation worries.