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BOK risks being forced to sharply hike rates: Nomura

01-31-2011 16:14 BJT

SEOUL, Jan. 31 (Xinhua) -- South Korea's central bank might be forced to raise interest rates sharply, a Japanese investment bank said Monday.

"The Bank of Korea (BOK) could be forced to sharply hike rates if the transmission mechanism of monetary policy does not work," Kwon Young-sun, an economist at Nomura Holdings in Hong Kong, told Xinhua.

The transmission mechanism is functioning through three channels, including foreign exchange (FX), credit and market expectation, but the malfunctioning of any of the channels will force the BOK to raise its benchmark interest rate more quickly, Kwon said in a phone interview.

In normal market conditions, monetary tightening by central banks limits inflationary pressures by appreciating the local currency, curbing demand for mortgage financing and containing inflation expectations.

Long delays in rate hikes, however, lead to a vicious tightening cycle where the central bank ups rates to catch up with the inflation curve, the transmission mechanism does not work and both growth and inflation rise, forcing the bank to lift rates again and again.

The analyst noted that the BOK risks being faced with such a cycle, stressing South Korean FX authorities and financial regulators should help make the transmission mechanism operate normally.

The FX authorities should allow the South Korean won to rise against the U.S. dollar if higher global bond yields limits the local currency's appreciation in the future, he said.

Kwon said he sees upside risks in the global bond yields, including the United States and Europe as well as emerging economies, adding that better business confidence in the United States may help the world's largest economy grow faster than expected while the Europe's inflation above the target range of the European Central Bank (ECB) could trigger the ECB's rate hike in September.

South Korea's financial regulator should also end its deregulation of mortgage financing, which is supposed to finish in March, to make the credit channel effective, he said.

If the policymakers become complacent with any temporary signs of stabilizing inflation, fueling property market speculation, then this could be positive for asset prices in the short term though it might deteriorate the transmission mechanism through the expectation channel, he added.

Editor:Du Xiaodan |Source: Xinhua

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