Wednesday, April 10, 2013

Korea holds rate, keeps eye on impact of geopolitical risks

    South Korea's central bank held its base rate steady at 2.75 percent, saying the domestic economy is  continuing to expand on the back of a recovery in exports and investments but the pace is weak and consumption has declined further, keeping inflation low.
    But the Bank of Korea (BOK), which cut rates twice in 2012 by a total of 50 basis points, said it would "closely monitor external risk factors and Korea's geopolitical risk and any consequent changes in financial and economic conditions."
    Financial markets were split in their expectations to the BOK's decision, with a growing number of economists expecting a cut to boost confidence in light of the recent threats from North Korea, the growing competition from Japan and its weaker yen, and the Korean government's pressure for the central bank to stimulate the economy to avoid a slowdown in the second half of the year.
    The BOK's assessment of the economic outlook is largely steady from last month, when it also said it expected the economy to operate below its potential "for a considerable time, due mostly to the slow recovery of the global economy." This month, however, it added that the influence of the weak yen would also contribute to the negative output gap.
     Nevertheless, the BOK expects the global economy to sustain its modest recovery, based on continued growth in the U.S. and an improvement in China and emerging markets. 

    There are still downside risks to the global economy, the BOK said, referring to a delay in the economic recovery in the euro area, which remains sluggish, and the impact of fiscal consolidation in the United States.
    The BOK added that stock prices had fallen substantially and the Korean won had "depreciated significantly" against the U.S. dollar as foreigners had withdrawn some investment funds in connection with "the reemergence of euro area risk and with the increase in geopolitical risk in Korea."
    South Korea's headline inflation rate has been easing recently and dropped to 1.3 percent in March from 1.4 percent in February and January's 1.5 percent, well below the BOK's 2.5-3.5 percent range for the 2013-2015 period. Core inflation rose slightly to 1.5 percent in March from 1.3 percent.
    Although inflation remains low due to weak demand, the BOK said it expects inflation to rise as downward pressure from "institutional factors" disappear.
    South Korea's economy expanded by 2.0 percent in 2012, down from 2011's 3.6 percent, with Gross Domestic Product in the fourth quarter up by 0.3 percent from the third quarter for annual growth rate of 1.5 percent.

   The government recently cut its 2013 growth forecast to 2.3 percent, below the BOK's forecast of 2.8 percent from January, and is now planning an additional budget, not only to make up for the expected revenue shortfall but also to add stimulus.


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