News & Reports News Year 2011 April , 2011 S.Korea inflation fears grow, banks brace for won crackdown

S.Korea inflation fears grow, banks brace for won crackdown

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South Koreans expect inflation to remain at the top end of the central bank's target over the next year, indicating it has failed to dampen concerns over rising prices, as authorities looked set to take action to curb the rising won currency and a surge in foreign debt.

Consumers' inflation expectations -- the median inflation forecast for the next year -- rose to 4.0 percent in April, a 22-month high, from 3.8 percent in a March survey, the central bank said on Tuesday. The top end of the central bank's inflation target is 4 percent. ""These indicators ... back the consensus view that more interest rates may be needed to contain inflation expectations,"" said Kim Jin-seong, an economist at Hanwha Securities.

The central bank left interest rates unchanged at its April meeting despite clear signs of unease among its members over mounting inflation, which raced to a 29-month high of 4.7 percent in March. Minutes of its March meeting, also released on Tuesday, showed policymakers believed that delaying a rate hike ""would be a very dangerous policy decision"".

At that meeting, the policy board voted 4-1 to raise rates by a quarter point to 3.0 percent. One policymaker who was not identified in the documents warned the annual inflation rate ""could soon rise above 5 percent."" While some traders maintain the central bank has been sending confusing signals about its intentions, other market watchers believe Seoul recently opted for a more direct tactic to contain price pressures, grudgingly allowing the won to rise to curb imported inflation.

But authorities now appear to be readying to apply the brakes on the won, fearful that speculation on further won gains is creating a potentially destabilizing surge in short-term foreign debt. Banks have been borrowing to fund forward foreign exchange deals with local exporters. Two sources with direct knowledge of the plans told Reuters that South Korea will likely trim the ceilings on banks' foreign exchange derivatives positions by at least one-fifth after an inspection of banks is concluded next week.

""Once the government were to change them, the ceilings will likely be (reduced to) 200 percent and 40 percent as widely expected in the markets,"" said one source, compared with 250 percent of equity set for foreign bank branches and 50 percent for domestic banks. The won suffered its worst daily loss on Tuesday in two weeks after the moves were mooted.

The won has jumped around 5 percent against the dollar in less than a month to hit a 31-month high last week but has since then retreated slightly, partly on talk of massive dollar-buying intervention aimed at stopping the surge. South Korea is inspecting currency derivative trades by four banks -- including two foreign bank branches -- and looks close to trimming by at least one-fifth the maximum amount of derivatives each bank can carry. ----Consumer sentiment improves Despite the growing worries that high inflation will persist well into next year, other data on Tuesday showed consumers may be more resilient than first thought.

The central bank's consumer sentiment index, which measures how South Koreans assess the economic outlook and their future living standards, rose to 100 in April after hitting 98 in March, when the reading was at its lowest since April 2009. The index reversed a four-month falling streak since hitting 110 in November last year.

A reading above 100 means those consumers who were optimistic about the future economy and living standards outnumber the pessimists. Analysts said the survey results underscored the market's view that the Bank of Korea would deliver a fifth interest rate increase as early as next month, despite its reluctance to back a rise in April
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