UPDATE 1-S.Korean government ready to aid banks as won jumps

(Updates throughout)

By Cheon Jong-woo

SEOUL, Oct 14 (Reuters) - South Korea pledged its support on Tuesday for local banks struggling in the face of the global financial turmoil, although signs the crisis may be turning boosted the won and sparked the biggest share rally in six years.

The finance ministry promised to keep pumping liquidity into the banking system until the market stabilises, adding it was considering whether to guarantee the foreign currency debts of the country's banks given the risks they face in trying to raise dollar funds from dried-up credit markets.

Finance Minister Kang-Man-soo, who had suggested last week that local banks sell overseas assets to raise the dollars they need, was reported making similar remarks earlier in the United States.

But economists said the finance ministry may be jumping the gun with its latest suggestion.

"The situation is not as bad that we need a government guarantee for banks' foreign currency debts. The minister seemed to mean that the government would take steps if the global credit crunch gets worse and local banks have trouble trying to get foreign currency funding," said Park Sang-hyun, chief economist at HI Investment & Securities.

Instead, markets signalled that the financial storm unleashed by the collapse of Lehman Brothers (LEHMQ.PK) last month may have reached a turning point.

The won KRW=, which crashed last week to a decade low, rallied to its highest level against the dollar in over two weeks.

Asian currencies and global stocks also rallied after news that the United States will announce plans later on Tuesday to inject up to $250 billion into its banks. European countries have pledged to pump more than 1 trillion euros ($1.4 trillion) into their banks.

The won ended local trading up 2.5 percent at 1,207.4/8.1 to the dollar, clawing back some ground lost in two of the wildest trading sessions in the won since the Asian financial crisis in 1997/98 almost pushed South Korea into default.

Korean share prices also jumped, posting their biggest one-day gain in over six years, with the main index ending up 6.1 percent at 1,367.69 points -- that brought gains on the week to 10 percent, recovering most of last week's 12.6 percent drop.

ECONOMIC CLOUDS

Despite the latest optimism, analysts and economists said the impact of the global financial crisis meant South Korea's economic prospects, heavily reliant on worldwide demand for its exports, were gloomy.

"There is a worry in every investor's mind that the current economic slowdown may be a long-lasting one," said Yoo Soo-min, a market analyst at Hyundai Securities.

The head of the central bank said the outlook for Asia's fourth-largest economy remained tough with demand at home and internationally certain to dip.

"It would be difficult for the economy to grow 4 percent (annually) in the fourth quarter and until the first half of the next year," Bank of Korea Governor Lee Seong-tae was quoted by his office as saying in Washington.

"It is also difficult to confidently say that the economy would get better in the second half," he added. The economy expanded at a rate of 5.0 percent in 2007.

South Korea's financial institutions have looked especially vulnerable to the credit crunch as local banks have had to scramble to find dollars to service short-term debts. They also face the prospect of some clients struggling to pay off loans as domestic and international economic growth slows.

Two of the country's major exporters -- steel giant POSCO and flat-screen maker LG Display Co Ltd (034220.KS) -- both warned investors that their business outlook was difficult because of the global economic downturn.

BOK Governor Lee said inflation would be the top priority in deciding interest rate policy by the central bank, which last week followed global moves by cutting rates by 0.25 percentage point. He repeated the government's pledge to dip into foreign exchange reserves of $240 billion -- the world's sixth largest -- to help relax the dollar funding squeeze at home.

"A central bank wants the market to solve it ... (But) we will act as the last resort with our foreign exchange reserves, although we need to be careful as we don't know how long the recent turmoil would last," he said. (Additional reporting by Park Jung-youn, writing by Jonathan Thatcher; Editing by Neil Fullick)