Bank of Korea raises interest rate

July 12 (Bloomberg) -- South Korea's central bank raised its benchmark interest rate to a six-year high on concern record lending to small companies may spur inflation.
Bank of Korea Governor Lee Seong Tae and his board colleagues today lifted the overnight call rate by a quarter percentage point to 4.75 percent, the first increase since August 2006. Eight of 15 economists surveyed by Bloomberg predicted the rise and seven expected no change.
``It's a prudent decision,'' said Park Sang Hyun, chief economist with CJ Investment & Securities Co. in Seoul. ``If the cresting money growth is left unchecked, it could reignite a property market rally and ultimately fan inflation.''
Loans to small businesses soared to an all-time high last quarter as lenders sought new corporate customers to overcome tighter rules for mortgages. Governor Lee says Korean financial institutions have a ``herd mentality'' that's fuelling the supply of money and poses an inflation risk.
The Kospi stock index rose 1.36 percent to a record 1915.75 and the won gained 0.1 percent to 918.40 versus the dollar at 11:05 a.m. in Seoul. The benchmark five-year government bond yield was unchanged at 5.39 percent.
The Bank of Korea today also raised rates on so-called aggregate loans, which are offered to local banks at a special rate to help spur lending to small companies, to 3 percent from 2.75 percent. Rates on liquidity-adjustment lending were increased to 4.5 percent from 4.25 percent.
Loans Growth
Loans to small and mid-sized companies jumped 8.34 trillion won ($9.1 billion) in June from May, the largest gain since the central bank began compiling figures in December 2000, according to a report yesterday.
South Korea's monetary policy should take aim at ``controlling liquidity,'' as an excessive supply of money could push up prices and result in an asset bubble, Finance Minister Kwon Okyu said last week.
Kwon's comments echo those of the central bank governor, who said the Bank of Korea will engineer a slowdown in money growth and lending demand that could undermine the economy's longest stretch of expansion in a decade.
In an earlier effort to slow borrowing, the central bank on June 21 reduced the funds it makes available for loans to small businesses for the first time in six months. Last year, the bank ordered commercial lenders to hold more money as reserves. It raised borrowing costs three times in 2006 and tightened rules to cool lending and damp demand in the housing market.
`Abundant Liquidity'
``There's abundant liquidity in the financial market and lending has increased sharply, led by loans to small and mid- sized enterprises,'' the central bank said in a statement today. ``The upwardly adjusted call rate target would still be supportive of ongoing economic recovery.''
Growing signs of economic revival are helping to support today's decision. The Bank of Korea and the government this week raised their 2007 growth forecast. Moody's Investors Service says it may upgrade the nation's credit rating and reports in the past week showed exports surged in June and consumers became the most confident in 15 months.
The economy will advance 4.6 percent this year, more than an earlier prediction of 4.5 percent, the Ministry of Finance and Economy said in its second-half policy report. The Bank of Korea raised its forecast to 4.5 percent from 4.4 percent.
Growth in Asia's third-largest economy will quicken in the second half of 2007 and is expected to be faster in 2008 than this year, the central bank said in a statement today.
More Increases
Some economists forecast the central bank will deliver one or two more increases by the first quarter of 2008, according to a Bloomberg survey. Others say higher borrowing costs could choke off a recovery in the economy that is ``lukewarm.'' Recent gains in the currency may also deter the central bank from increasing rates further.
``Nothing in the economic data justifies that move, so it's a bit of a nail biter right now,'' said Frederic Neumann, an economist with HSBC Markets Ltd. in Hong Kong. ``If they stayed there, that would help the economy to recover. It isn't out of the woods yet.''
South Korea's government is seeking stability in the currency market as gains in the won threaten to erode overseas earnings for Samsung Electronics Co. and other exporters. Finance Minister Kwon said this week the government will actively respond to the won's strength when necessary.
The won has gained 1.2 percent over the past month against Japan's yen, the currency of its major export competitor, reaching the highest in 10 years.