September 10, 2009 / 6:47 AM / 10 years ago

UPDATE 3-Bank of Korea signals tightening, bonds slide

(Adds Reuters poll, finance ministry official comments)

* Bank of Korea leaves rates at record low as expected

* Governor says decision on policy “belongs to us”

* Remarks signal an early tightening, pound bond futures

* Property boom, economic growth boost case for early raise

* Apparent support for rate hike by Finance Ministry

By Seo Eun-kyung

SEOUL, Sept 10 (Reuters) - Bank of Korea sent a strong signal on Thursday it would lift interest rates if house prices climb much more, even if it means jumping the gun on other major central banks, boosting bets on a rise as early as November.

Governor Lee Seong-tae, whose hawkish sent treasury bond futures down over half a percent, made clear he would not be swayed by a government which has repeatedly leaned on the central bank to keep monetary policy loose to help boost growth.

But the finance ministry appeared to give its blessing to a slight tightening by saying even if rates did go up now, monetary policy would still be expansionary — echoing Lee’s own comments.

The central bank, as expected, on Thursday kept interest rates at the 2.0 percent record low set seven months ago to protect Asia’s fourth largest economy from the global downturn.

The governor’s suggestion the risk of a house price bubble was cause enough to tighten policy, comes amid heated debate among U.S., euro zone and Australian central bankers how to respond to a risk of asset bubbles as the global economy sputters towards recovery.

“There’s no problem at the moment with the consumer prices and international balance of payments but I am worried about the housing sector,” Lee, expected to step down next March at the end of his term, told a news conference.

“The final decision on when and how much to adjust its policy depends on each country’s situation,” he said, adding last weekend’s pledge by G20 finance ministers to stick to policies that supported growth was aimed mainly at soothing markets.

BUBBLE WORRY

The Bank of Korea is now poised to become one of the first major central banks to shift towards tightening. Other contenders in the region include Australia, China and India.

It has also most explicitly linked asset prices with possible policy action. The debate whether it should be a central bank’s job to prevent speculative bubbles is not new. But fears that record low global interest rates and massive liquidity injections will sow seeds of new bubbles long before inflation starts creeping up to unacceptable levels lent the debate new urgency.

“The bias is now very clearly on the upside for interest rates. He wants to say that he remains very much in control,” said Sebastien Barbe, senior economist and currency strategist at Calyon. “If necessary, they could increase interest rates sooner than what most are thinking in the market and sooner than other central banks.”

Some analysts said an increase in rates could help calm the housing market, whose rise policymakers worry distort what looks to be South Korea’s earlier-than-expected economic recovery.

“A higher benchmark rate may increase household’s burden of borrowing costs, but if the BOK raise rates gradually, the impact will be reduced while cooling property markets,” said Kim Jae-eun, an economist at Hyundai Securities, and one of those predicting a November rate rise.

Consumer inflation is relatively low despite an uptick in August, but housing prices, which did not suffer significant falls during the global crisis, are now on the rise.

The governor’s remarks rattled bond investors, coming shortly after a central bank statement reassured them it would maintain monetary easing stance for the time being.

But Lee argued that bank policy would still be considered easy even if it did push rates up from the current record low.

September treasury bond futures reversed early gains to fall more than 0.60 percent. Stocks and the won showed muted reaction.

RATE COULD RISE SOONER

Eight out of 14 analysts polled by Reuters after Lee’s comments still predicted the first rate rise to come next year, while six bet on a move in the final quarter of this year. Several said, however a risk of an early move has risen considerably. [ID:nSEO110874]

The Bank of Korea cut its 7-day repurchase agreement rate by a total of 3.25 percentage points over four months from October to counter the downturn.

It also poured money into the financial system, participated in quasi-official funds to recapitalise domestic banks and stabilise the bond market, and sealed about $90 billion in emergency credit lines with three countries.

President Lee Myung-bak rose to power a year and half ago with pledges to sharply lift economic growth and his top officials have repeatedly said it was too soon to remove the stimulus.

The previous day, Finance Minister Yoon Jeung-hyun said it was too early to talk about any exit strategy, which many in the market have taken as pressuring the central bank to stay on hold.

On Thursday, Governor Lee retorted by saying the final decision on monetary policy is “up to us”.

A senior finance ministry official later played down suggestion of a conflict, telling Reuters the government could tolerate a little tightening.

“Even if interest rates are raised, we can say the expansionary policy will be maintained,” he said, asking not to be identified as he is not authorised to speak to the press. (Additional reporting by Lee Eun-yul, Cheon Jong-woo and Jon Herskovitz, Writing by Yoo Choonsik; editing by Jonathan Thatcher and Tomasz Janowski)

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