South Korea central bank switches tack to growth, adds to rate cut view

SEOUL Tue Oct 2, 2012 4:28am EDT

A man gets on a bicycle in front of the Bank of Korea in Seoul August 9, 2012. REUTERS/Kim Hong-Ji

A man gets on a bicycle in front of the Bank of Korea in Seoul August 9, 2012.

Credit: Reuters/Kim Hong-Ji

SEOUL (Reuters) - South Korea's central bank promised on Tuesday to direct policy at shoring up the sputtering economy, as a survey showed the manufacturing sector shrank by the most in nearly four years, adding to expectations it will cut interest rates next week.

The comment, contained in its policy report to parliament, marked a shift in emphasis toward encouraging growth from its statement last month that had stressed price stability as the prime objective.

Bond prices rallied as traders took the comment as making it more likely for the Bank of Korea to lower interest rates at its October 11 meeting.

"The Bank of Korea plans to manage monetary policy for economic growth to recover to the potential rate while ensuring inflation remains stable at the middle of the target range," the central bank said in the report.

A private survey of South Korea's manufacturing sector, official inflation data and a housing price report, all for September and released on Tuesday, also supported the case for policy easing next week.

EXPORTS FALTERING

"Given that external demand remains weak, growth must be sustained from within," said Ronald Man, an economist at HSBC in Hong Kong. "The chances of a 50 bp rate cut appears unlikely, as this may be considered too aggressive and can signal panic to the markets."

Minutes from the central bank's September policy meeting, released later on Tuesday, also showed many of the seven-member policy board preferred a cautious approach in cutting rates, with one saying the country should now accept a lower rate of growth than before.

Government bond yields fell sharply across the board, with the 10-year yield KRTSY10Y=KQ ending down 5 basis points at 2.97 percent, below the Bank of Korea's 7-day policy interest rate of 3.0 percent.

Bond prices also received a boost after Australia's central bank cut interest rates by a quarter point to a three-year trough of 3.25 percent on Tuesday, a move not totally unexpected but which came earlier than many had expected.

FACTORY ACTIVITY SHRINKS FURTHER

The HSBC/Markit purchasing managers' index (PMI) on South Korea's manufacturing sector fell to a 43-month low of 45.71 in seasonally adjusted terms, marking the fourth consecutive month of contracting activity.

And though annual inflation in September picked up to 2.0 percent from a 12-year low of 1.2 percent in August, this was still well below the central bank's 3 percent target, providing room for additional easing.

The country's top mortgage lender also released data on Tuesday highlighting weak consumer sentiment, with housing prices falling for a third consecutive month in September, marking the worst sequential decline since early 2009.

Other recent data showed top department and discount store sales fell for a third straight month in August against a year earlier, underscoring the deepening slump in domestic demand even as external conditions deteriorated.

Analysts said the central bank's change in rhetoric should not be taken as indicating it would cut interest rates more aggressively but as showing it admitted to the heightened pressure for a cut, making an imminent cut more likely.

In July, the bank trimmed its policy rate by 25 basis points to 3.0 percent in a surprise move, and has since kept it unchanged to monitor the effects of additional stimulus measures in Korea and other major economies.

Recent indicators have shown that Asia's fourth-largest economy has lost momentum more rapidly than expected as global demand slumped in the shadow of Europe's protracted crisis.

Quarterly economic growth dipped to 0.3 percent in April-June from 0.9 percent in the first quarter, and third-quarter growth is expected to be similar to the second quarter.

(Additional reporting by Christine Kim; Editing by Simon Cameron-Moore & Kim Coghill)

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