south korea

Bullish comments from the Bank of Korea today, even as it kept the 7-day repurchase rate on hold at 2.75 per cent. By the Bank’s own forecasts, consumer price inflation will rise above the 3 per cent target to 3.5-4 per cent this year. South Korea’s central bank surprised markets with a 25 basis point rate rise in mid-January – one of a number of inflation-fighting techniques the Bank has introduced.

Inflation is firmly on the Bank’s radar; the statement leaves no room for doubt. The strength of conviction suggests another rate rise is not far ahead: 

Money Supply - Click for interactive interest rate graphicCentral bankers in Seoul have raised the base rate by 25bp, taking it to 2.75 per cent. While the move was unexpected, it is not surprising. The Bank of Korea has taken numerous measures to combat inflation in recent weeks, even doubling the availability of staple food sources to help contain food price inflation. In December, the country announced plans for a bank levy on foreign-currency debt; the bill, yet to be finalised, could become law in the second half of this year.

In a statement issued with the decision, the Bank’s tone was generally upbeat, but concerns persist around asset prices: 

Lower-than-expected growth in Brazil and New Zealand have prompted their central banks to maintain rates; in South Korea, “greatly decreased” inflation motivated the hold decision, in spite of a “continued upward trend” in growth.

Brazil’s monetary policy committee, Copom, kept the Selic rate at 10.75 per cent, hinting that a rate cut might have been on the cards were it not for recent macroprudential policies, whose effects on monetary conditions were yet to be seen. 

Seoul raised its base rate 25bp to 2.5 per cent today, citing rising inflation and an appreciating currency, as well as – more positively – continued growth expected in South Korea.

Growth in the country has moderated recently, slowing to 0.7 per cent in the three months to September, from 1.4 per cent in the three months prior. Nonetheless, continued growth is expected, and Goldman Sachs analysts expect the base rate to reach 3.25 per cent by the end of 2011. 

South Korea, holder of the world’s fifth-biggest foreign exchange reserves, is considering expanding its small holdings of gold to diversify its dollar-heavy portfolio.

Such a move could prove significant to the international gold market as Seoul currently only holds about 14 tonnes of the lustrous metal, equal to just 0.2 per cent of its $290bn reserves at current prices. By contrast, Italy and France each hold just under 2,500 tonnes of gold, amounting to more than 65 per cent of their reserves. 

Hot money? South Korea isn’t encouraging any more – the central bank on Thursday held its base rate at 2.25 per cent. The decision has surprised Reuters analysts who had expected a 25bp raise.

Bond prices have risen to record highs on the news and the won has also strengthened, though not as much as it would have done had interest rates risen. 

South Korea has maintained its base rate at 2.25 per cent, citing “the possibility of heightened volatility of economic activity in major countries”.

The central bank seems happy with continued domestic recovery, reporting buoyant exports and improving labour market conditions. 

Ahead of Friday‘s rate-setting meeting, the International Monetary Fund has sharply revised up its forecast for South Korean growth and urged the central bank to start raising rates. Growth for Asia’s fourth-largest economy this year is now forecast at 5.75 per cent, up from 4.5 per cent, Reuters reports:

“In light of the strong economic recovery, a carefully calibrated exit from supportive macroeconomic policies is appropriate,” IMF said in a statement. 

Two points stand out from the latest BIS quarterly review.

First, a warning on mismatched maturities. Ingo Fender and Patrick McGuire, of BIS, point out the continued reliance of European banks on wholesale* instruments and FX swaps. Banks forced to roll over short maturity debt risk agreeing new debt on worse terms. The authors point out that if conditions worsen, maturities will become even shorter, exacerbating the problem (p63):

Such funding patterns put a premium on contingency funding arrangements for international banks and underline the need for further diversification in banks’ funding profiles … In particular, they point to potential benefits from improvements to FX swap market infrastructure, such as the use of central counterparties to allow multilateral netting and more efficient collateral management

Second, Naohiko Baba (BoJ) and Ilhyock Shim (BIS) find 

Price stability is no longer a sufficient target for central bank policy, according to South Korean central bank governor Kim Choong-soo. “Perceptions as to the desirable role of the central bank are now shifting greatly,” he said at a speech commemorating the 60th anniversary of the bank.

Changes ahead for the Bank include expanding its remit to include financial stability; fostering closer ties with other central banks; and calling in consultants to help with the restructure. A key task was to work out how the goal of financial stability would fit with the “prime” goal of price stability.