Bank of Korea holds rates, March raise seen

South Korea's central bank kept interest rates on hold on Friday, surprising many economists who had expected a second consecutive rate increase as the authorities intensify their campaign to contain inflation.

The central bank has delivered two back-to-back rate increases only once before, but a majority of analysts surveyed by Reuters thought mounting evidence of rising price pressures in an expanding economy would compel it to do so again.

The Bank of Korea, however, kept its benchmark seven day repo rate at 2.75%, even though its policy statement predicted no let-up in price pressures in the months ahead.

"In the coming months, the committee expects high inflation expectations to continue and inflationary pressures to also persist as the economic upswing continues," it said.

Bank of Korea Governor Kim Choong-soo told a news conference that Friday's decision to keep rates on hold was not unanimous. He also said inflation was expected to stay around 4% for the time being, the upper end of the central bank's 2-4% target range.

Bond futures spiked up after the rate announcement, but later erased their gains as traders saw the decision as marking just a brief pause in a tightening cycle and saw the next move coming as soon as in March.

Analysts said that, despite a clear case for further tightening, the central bank must have felt it needed some time to assess the impact of January's quarter-point rate rise as well as the government's efforts to curb price rises.

"While the government is preparing micro-measures against inflation, it probably thought a rate rise would burden consumers more, along with heavy mortgage loans," said Sun Yoo, analyst at Woori Investment & Securities.

"The central bank therefore decided to take a breather, and is seen raising rates in March. I think the BOK will raise rates to 3.75% by the end of this year, as the economic situation has recovered to that seen before the financial crisis," he added.

Producer price data -- a harbinger of consumer price inflation in months ahead -- earlier on Friday offered the latest evidence of inflationary pressures building in Asia's fourth-largest economy.

Prices at the factory gate rose 6.2% in January from a year earlier, the fastest increase in 26 months.

The rise was largely driven by rising energy and food prices, but the central bank said demand-driven inflationary pressures were also on the rise.

The figures follow earlier data that showed consumer inflation expectations at an 18-month high in January and last month's inflation above the central bank's target at 4.1%.

Out of 21 analysts polled by Reuters 13 had predicted a rate rise on Friday and eight saw an increase either in March or April.

President Lee Myung-bak, who until recently focused policy on boosting economic growth, declared a "war on inflation" early this year.

Economists say the central bank still has some way to go with policy tightening, despite three rate increases during the past seven months, given that annual consumer inflation has stayed above the policy interest rate for more than a year.