Bloomberg News

Bank of Korea to Debate Rate Rise as Growth Risks Multiply

June 09, 2011

(Updates with lending data in 10th paragraph.)

June 9 (Bloomberg) -- The Bank of Korea will weigh an interest-rate increase tomorrow as swelling household debt and weakness in the global economy pose threats to growth.

Nine of 17 economists expect the benchmark rate will stay unchanged at 3 percent, while eight forecast an increase of a quarter of a percentage point, a Bloomberg News survey shows.

Officials must decide whether protecting the nation’s expansion is more important than taming inflation that’s exceeded a 4 percent target ceiling each month this year. Economists have found it difficult to predict the central bank’s policy moves, with their median estimates proved wrong in six of the past 12 decisions.

“It’s hard to predict what the Bank of Korea will do with rates this week given its surprising moves in the past,” said Eugene Kim, chief investment officer at Samsung Asset Management Co., South Korea’s largest bond-fund manager. “Risks to growth have increased since they unexpectedly kept rates on hold last month. But they might go ahead with a rate hike belatedly to tame inflation.”

Rising unemployment in the U.S. and Europe’s debt crisis may threaten demand for the nation’s exports, which are equivalent to about half of economic output. Within South Korea, bank lending to households rose to a record in April, underscoring official warnings on the risks from excessive debt.

Bond Spread

Governor Kim Choong Soo’s officials raised rates by 25 basis points in January and March before unexpectedly keeping them unchanged last month. He said on May 18 that the Bank of Korea will continue to boost borrowing costs at its own pace and also that the nation needs to be wary of an inflation spiral.

The spread between rates on two- and 10-year government debt narrowed to a 29-month low of 68 basis points on May 30 as yields fell on both securities, suggesting policy makers will keep borrowing costs unchanged tomorrow, according to Daewoo Securities Co. That gap held close to that level, at 71 points, yesterday.

Nomura Holdings Inc. dropped its call for a June rate increase and said it now expects the bank to boost rates by 0.5 percentage point in the next 18 months compared with its previous projection of 1 percentage point. The central bank will focus more on downside risks to growth than inflation risks, said Kwon Young Sun, a Hong Kong-based economist at Nomura.

Record Household Debt

The Financial Services Commission said this week authorities need to pay special attention to household debt, “which may weigh considerably on the financial market.”

Household debt rose to a record 801.4 trillion won ($740 billion) in the first three months of this year, the Bank of Korea said on May 25. Bank lending to households rose by the most in six months in May, increasing 3.3 trillion won to 439.8 trillion won, the central bank said today.

Financial liabilities of individuals in South Korea were 155.4 percent of disposable income at the end of 2010, “one of the highest ratios globally” and still climbing, Young Il Choi, an analyst at Moody’s Investors Service, said in a report last month.

South Korea’s economy grew 4.2 percent in the first quarter from a year earlier, unchanged from an earlier estimate, the central bank said yesterday. The economy expanded 1.3 percent in the three months through March from the previous quarter, less than the April estimate of a 1.4 percent gain.

Political Pressure

The nation’s exports were a record $49 billion in April and overseas demand has bolstered sales for carmakers including Hyundai Motor Co. this year. In contrast, domestic investment and consumption were sluggish in April, the statistics agency said on May 31.

Wai Ho Leong, a senior regional economist at Barclays Capital in Singapore, said the central bank may raise interest rates tomorrow to help tame prices. The BOK may also want to push ahead now because it may be harder to raise rates later in the year as the government prepares for parliamentary and presidential elections in 2012, he said.

“The risk is that with elections looming closer next year, it may face increasingly more political pressure to slow its rate normalization,” said Leong, who expects two more rate increases this year after a move tomorrow.

President Lee Myung Bak’s public support has dwindled partly due to the rising cost of living. His rating fell to 27.1 percent in a May 23-27 poll compared with 76 percent when he came to power in February 2008, according to Seoul-based Realmeter.

Lee declared “war” on inflation in January, and the government imposed price controls and tolerated currency appreciation as part of the campaign. The won has climbed more than 4 percent against the dollar so far this year.

Consumer prices rose 4.1 percent last month from a year earlier after a 4.2 percent gain in April. Core prices, which exclude fuel and food prices, advanced 3.5 percent in May from a year earlier.

--With contributions by Lilian Karunungan in Singapore and Yumi Teso in Bangkok. Editors: Ken McCallum, Lily Nonomiya

To contact the reporter on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net; Sarina Yoo in Seoul at kyoo3@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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