The Bank of Korea froze the benchmark rate at 3.25 percent on Friday for the seventh straight month as widely expected, citing risks to the global and local economy.

One refreshing change, though subtle, is that Gov. Kim Choong-soo stressed the central bank would monitor closely the still-high “inflation expectations” instead of focusing on inflation growth. 

Kim said inflation expectations among the public remain at about 4 percent, while expert groups forecast 3.4 percent growth for 2012.

“The gap in inflation expectations is a task that should be addressed,” Kim told reporters after the rate decision.

His remark that focused on “expectations” is interpreted as a sign that the central bank would keep the rate unchanged for a considerable period of time, unless inflation growth spirals out of control.

In a statement, the BOK said it will “conduct monetary policy so as to stabilize consumer price inflation at the midpoint of the inflation target over a medium-term horizon amid continuing sound growth of the economy.”

Kim said the emphasis on the midpoint of the inflation target ― 3 percent, as the bank’s goal is 2-4 percent ― is largely intended to keep long-term inflation expectations under control.

The BOK expects consumer prices to stay at a relatively high level of 3.5 percent in the first half of this year but soften to 3.1 percent in the second half. The yearly projection by the bank is pegged at 3.3 percent.

In contrast to headline inflation, Kim said core inflation, which excludes volatile food and energy prices, would stay low in the first half but move up in the second.

Korea’s inflation growth hit the upper ceiling of the central bank’s target band last year, raising the issue of whether the BOK should have moved more aggressively to tighten the monetary policy.

Analysts are now divided on the rate-setting direction. Some argued the central bank might cut the rate, possibly in the second quarter, to help the export-dependent economy safeguard its growth in the face of external risks such as the eurozone crisis; others claimed that a rate hike aimed at taming inflation might be needed in the second half, especially if core inflation rises out of control.

Seemingly aware of the mixed expectations among analysts, the BOK chief said keeping the rate unchanged on Friday was “a very difficult decision to make.”

“People think the rate should be either cut or raised, but freezing the rate is equally important,” Kim said, offering a further sign that the stance is likely to be maintained.

As for other policy measures such as a change in bank reserve requirement to tackle inflation, Kim said such options are secondary and the central bank’s rate-setting is the most fundamental tool to stabilize prices.

Asked about the local economy’s growth outlook, Kim said the actual figures for fourth-quarter gross domestic product might be lower than its earlier projection of 1 percent growth from the previous quarter and 4 percent from the year-earlier period.

Asked of the chances of monetary normalization, Kim said he keeps the same official position that once certain conditions such as external risks and inflation figures are met, the central bank would opt for raising the rate.

Analysts said the BOK would find it no easy task to change the rate, regardless of direction.

“The rate would remain unchanged in the first half of this year, and only if the conditions improve toward the fourth quarter might a rate increase be considered,” said Jason Lee, analyst at KB Investment & Securities.

Hong Jung-hye, an analyst at Shinyoung Securities, said the BOK is now stuck in the middle of a tug of war between upward and downward pressure.

“Downside risks to the economy mean the central bank might be required to cut the rate, but it cannot do so because of the inflationary pressure that calls for a rate hike,” Hong said, adding that no-change policy would be extended longer than expected.

Choi Dong-cheol, analyst at Woori Investment & Securities, said Kim’s emphasis on monetary normalization was less pronounced on Friday, suggesting that a rate cut might be more feasible.

“Given the worries Gov. Kim expressed over both the global and domestic economy, the central bank is likely to slash the rate in the late second or early third quarter,” Choi said.

The central bank has raised borrowing costs by a combined 1.25 percentage points in five steps since July 2010 to tame inflation.

By Yang Sung-jin
(insight@heraldcorp.com)