(Updates original story with BOK's revised growth forecast)
South Korea's central bank held its base rate steady at 2.50 percent and expects inflation to gradually rise in the second half of the year from last year's low base while the economy continues to grow weakly and will be below its potential output for a "considerable time going forward" due to the slow recovery of the global economy.
The Bank of Korea (BOK), which cut rates by 25 basis points in May, said exports had generally been favorable while "indicators of domestic demand have alternated between improvement and worsening."
The global economy is expected to continue its "modest recovery going forward" but the BOK considers the downside risks to growth to comprise "the possibility of an earlier-than-expected tapering off of US quantitative easing and a slowdown in Chinese economic growth, and to the implementation of fiscal consolidation in major countries."
Just as in major international financial markets, Korea's markets have been volatile in recent months with stock prices falling substantially due to outflows of foreigners' investment funds and long-term market interest rates rising in concert with those of major economies.
"After having depreciated greatly, the Korean won has appreciated to a considerable extent," the BOK said.
Following the Bank of Japan's launch of a new more aggressive quantitative easing in early April, the won rose over 10 percent against the Japanese yen through late May, causing concern over the competitiveness of Korean exporters. But the won then reversed course until mid-June when it started rising again.
Compared with the start of the year, the won has risen almost seven percent against the yen, quoted at 11.33 per yen earlier today.
In response to the slower-than-expected recovery and the additional competitive pressure on South Korea's exporters from the higher won, the government in May approved a 17.3 trillion won supplementary budget - its third largest ever and only surpassed by stimulus after the 1998 Asian crises and the 2008 global financial crises.
The government expects the budget should help boost economic growth to 2.8 percent this year from 2.0 percent in 2012 and the BOK also raised its Gross Domestic Product growth forecast for 2013 to 2.8 percent, up from its previous forecast of 2.6 percent, with GDP rising 3.7 percent in the second half of this year compared with 1.9 percent in the first half.
For 2014 the BOK now expects growth of 4.0 percent, up from its April forecast of 3.8 percent.
The main driver behind the higher forecast is construction investment, seen rising 4.5 percent this year, up from a previous forecast of 2.7 percent, while exports are seen rising 5.1 percent this year, down from a previous 5.2 percent. In 2014 exports are seen expanding by 8.0 percent, down from a previous forecast of 8.3 percent.
In the first quarter of this year, South Korea's GDP grew by 0.8 percent from the fourth quarter of 2012 for annual growth of 1.5 percent.
Korea's headline inflation rate was steady at 1.0 percent in June from May, continuing a declining trend seen since mid-2011. The BOK targets inflation of 2.5-3.5 percent.
In its latest forecast, the BOK revised downward its headline inflation forecast for this year, seeing prices rise by an average 1.7 percent, down from a previous forecast of 2.3 percent. In 2014 prices are forecast to rise by 2.9 percent, up from 2.8 percent.