South Korea's finance minister said on Tuesday the economy was in its worst trouble since the 1997 Asian financial crisis and markets took the comments as a warning to the central bank not to raise interest rates too much. The comments to parliament by Kang Man-soo helped September treasury bond futures rack up their biggest daily gain in six months as investors sharply scaled back their rate rise bets.
"Excluding exports, the environment including investment, consumption, job growth and current account is showing trends as serious as during the financial crisis," Kang told parliament.
Markets have been factoring in an interest rate rise as soon as next month after inflation hit a near 10-year high in June and the central bank stressed earlier this month its prime mission was to tackle inflation even as economic growth was slowing.
"Many people have priced in one interest rate increase, but they now think there will be no more increase because oil prices are falling and domestic demand is in slump," said Kong Dong-rak, a fixed-income analyst at Hana Daetoo Securities.
The Bank of Korea has kept interest rates steady since August 2007, but it has expressed growing unease about inflation moving further away from its 2.5-3.5 percent target range set for 2007-2009. It hit an annual rate of 5.5 percent in June.
This has set it on a collision course with the government of President Lee Myung-bak, who won elections last year in a landslide promising to sharply boost economic growth to 6 percent with a mix of tax cuts and deregulation. His popularity, however, has plunged when the economy failed to live up to the expectations.
Monetary policy tightening would make the government growth targets even less attainable and Kang has argued in the past a rate rise would do little to rein in inflation driven by high costs of imported fuels and food. Earlier, the Asian Development Bank trimmed its forecast for South Korea's economic growth to 4.7 percent for this year from 5.0 percent set three months ago and to 4.9 percent for next year from 5.2 percent.
It also raised its projection for consumer inflation rate for the year to a seven-year high of 4.1 percent from 3.4 percent seen in April and 2.5 percent in 2007. The treasury bond futures were already rising sharply on buying by foreigners who snapped up a net 5,135 contracts, the biggest daily net buying since April 25.
Separately, the finance minister defended a decision by his ministry and the central bank to dip into the country's nearly $260 billion foreign currency reserves - the world's sixth largest - to intervene in support of the won currency. The won had fallen 11 percent against the dollar in the first half of this year, contributing to inflation by increasing the local prices of imported goods.
However, the currency has rebounded 3 percent since July 7 when the authorities pledged to defend the won, with dealers estimating the authorities sold about $7 billion in the past two weeks. Kang said the decision, which was a stark shift away from a policy early this year of holding down the currency to narrow the current account deficit, was aimed at dealing with an exceptionally strong inflation.
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