South Korea's president on Tuesday sounded a slightly less cautious note on the economy, reinforcing bond investors' bets that local interest rates have hit bottom and may rise from early next year. President Lee Myung-bak said during a regular cabinet meeting that Asia's fourth-largest economy could be judged to have escaped the worst if gross domestic product for the April-June quarter improved.
The remark showed a slight improvement in the government's assessment of the economy from the past, when he and other government officials flatly dismissed as premature any market talk that the South Korean economy had started to recover. "The second-quarter (economic) performance will provide a yardstick for whether our economy has escaped from the crisis," a statement issued by Blue House spokesman Lee Dong-kwan quoted the president as saying. Analysts said South Korea's consumer inflation would remain low for the next several months, with energy prices lower than a year ago, but would then turn higher on growing expectations for an accelerating economic recovery.
"The global economic slump and the consequent fall in raw materials prices brought about a downturn in producer prices, but prices will start rising, although gradually, driven by excess liquidity and economic recovery hopes," said Kim Seung-hyun, an economist at Taurus Investment & Securities. Producer inflation data released on Tuesday by the central bank showed the country's producer price index fell 1.3 percent in May over a year earlier, its first annual decline in nearly seven years.
GROWING CHANCES OF RATE RISE A recent batch of upbeat economic data has prompted bond investors to increase bets that the country's central bank would start to raise interest rates over the next few months in a pre-emptive move to keep inflation expectations at bay.
The spread of yields between 1- and 10-year treasury bonds has widened to 274 basis points by Tuesday from as small as 210 points in late April as bond investors have been increasing their bets on chances of rate rises ahead. Analysts said the central bank could consider raising interest rates even before consumer inflation becomes an immediate threat out of concern that abundant cash liquidity would lead to asset price bubbles.
"Policymakers around the world are very much concerned about the effect of the massive fund injections since late last year on future inflation and could opt to take measures in a pre-emptive manner," said Lee Sang-jae, an economist at Hyundai Securities.
The head of South Korea's top financial regulatory agency said last week he would take measures should ample short-term liquidity "disturb" the markets.
The Bank of Korea cut the benchmark seven-day repurchase agreement rate by a total of 3.25 percentage points between October 2008 and February, and flooded the financial system with cash to keep the economy from shrinking too much. It has since held the rate steady at a record-low 2.0 percent.
A private survey on Tuesday showed all the bond traders surveyed forecast the central bank would hold the rate steady again at its next policy meeting on Thursday. South Korea's economy contracted by a seasonally adjusted 5.1 percent in the fourth quarter of 2008 from the previous quarter, but barely avoided falling into recession, posting a 0.1 percent rise in the first quarter of this year.