Bank of Korea freezes rates of 3.25% amid surging inflation

But DBS expects the BOK to raise the repo rate by 25bps in 4Q before taking it to 4% in 1H12.

According to DBS, both headline and core CPI inflation are expected to stay high at the 4.0% level in the remaining months of this year.

Here’s more from DBS:

The Bank of Korea (BOK) refrained from hiking rates from 3.25% at the monetary policy meeting yesterday in spite of inflation surging to 5.3% YoY. Worries about global economic outlook are the major explanation. The policy statement rephrased the part about global outlook by saying the recovery in advanced economies has exhibited signs of “further weakening” and “the possibility has increased” that the weakness in major countries will pose downside risks to the global economy.

The voting for freezing rates was not unanimous however, as disclosed by the central bank governor. The BOK still expects inflation to remain high for some time and admits the difficulty of meeting this year’s inflation target of 4%. The BOK’s stance of “conducting monetary policy with a greater emphasis on ensuring price stability while the economy continues sound growth” remains unchanged according to the statement.

We have pushed back one rate hike in our forecast, but maintaining the view that the rate cycle has not peaked. We continue to expect the BOK to raise the repo rate by 25bps in 4Q before taking it to 4.00% in 1H12.

Both headline and core CPI inflation are expected to stay high at the 4.0% level in the remaining months of this year, barring a substantial slowdown in exports that spills over to the broader economy and dampens the labour market outlook.

In fact the leading indicators don’t suggest that a sharp and broad growth slowdown is underway in 3Q/4Q. Despite the sentiment deterioration in the export dependent manufacturing industry, business sentiment in the domestically-driven sectors has remained stable. Consumer confidence is still fairly close to the neutral level. And the hard economic data have been doing better than the sentiment surveys thus far – exports have maintained steady growth as of August.

A double dip recession is still a low probability scenario and the chance is greater than 50% that the central bank will continue to normalize monetary policy in the coming quarters.

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