South Korea holds rates but suggests ready to cut

SEOUL (Reuters) - The Bank of Korea held interest rates steady on Thursday, as expected, but its governor's warnings that the economy was slowing boosted bets on a near-term rate cut and sent bond prices soaring.

The central bank left its benchmark rate unchanged at 5.0 percent for an eighth consecutive month but Governor Lee Seong-tae said that Asia's fourth-largest economy was faltering and predicted inflation would start to ease later this year.

The benchmark 5-year treasury bond yield fell below the policy rate for the first time and the won lagged behind other Asian currencies as analysts took Lee's remarks as suggesting the central bank was ready shore up the economy and cut rates for the first time since late 2004, perhaps as early as next month.

"The situation outside the country is worsening. Therefore, (the central bank) expects the local economy's growth to slow considerably when compared with expectations made a few months ago," Lee told reporters.

The remarks followed recent comments from top government officials suggesting economic policy would focus on boosting domestic demand rather than on fighting inflation.

"Based on Lee's remarks today, there's no reason why we have to wait further. It is possible even next month," said Kong Dong-rak, a fixed-income analyst at Hana Daetoo Securities, referring to the possibility of a rate cut at the May 8 meeting.

The central bank's chief spoke after pro-growth President Lee Myung-bank's party won parliamentary majority in Wednesday's elections, raising hopes of speedy reforms to boost the economy.

CUTS COMING

In a Reuters poll, all 16 economists had forecast the central bank would hold rates steady, but 13 expected rate to ease later in the year, with some seeing cuts totalling a full point.

The 5-year treasury yield KR5YT=KSDA fell 12 basis points to end at 4.93 percent, closing below the policy rate for the first time since the policy rate system was introduced in May 1999. June treasury bond futures KTBc1 jumped 44 ticks.

The won KRW= held steady against the dollar, whereas other Asian currencies were mostly higher.

The growing risk from a slowing global economy also made the International Monetary Fund cut on Wednesday its forecast for South Korea's 2008 economic growth to 4.2 percent from its previous 4.6 percent forecast.

Rising prices are a problem across much of Asia. In South Korea, inflation led by high commodity prices has been a source of concern for the central bank, but Lee sounded confident that it would head down later this year.

"Assuming that oil and raw materials prices stabilise in coming months and that the slowing global economy will affect prices, domestic consumer price growth will drop considerably and fall below the top end of the target band toward the year-end," Lee said.

Annual inflation picked up in March to match a three-year high of 3.9 percent first set in January, holding above the central bank's target band of 2.5-3.5 percent for a fourth month in a row.

But the target is set as an average rate for the 2007-2009 period, and the average rate since the beginning of 2007 now stands at just 2.8 percent, a Reuters calculation shows.

"As we always say, (the central bank) is managing monetary policy for the longer run," said Lee, indicating that policy would be guided by the likely future trend in inflation rather than the current high rate.

(Editing by Keiron Henderson and Tomasz Janowski)