South Korea’s central bank unexpectedly raised the key interest rate by a quarter percentage point on Thursday as economic growth and rising raw material prices are exerting mounting inflationary pressure.

Bank of Korea Governor Kim Choong-soo and his fellow policymakers hiked the benchmark seven-day repo rate, dubbed the base rate, to 2.75 percent. It marked the third rate increase since the onset of the global financial crisis.

The decision, which was not unanimous, came as a surprise as most analysts anticipated a rate freeze this month.

The BOK raised the borrowing cost by a quarter percentage point last July and November from a record-low 2 percent in an effort to normalize its loose policy stance and tame inflation.

The central bank expressed concerns about rising inflationary pressure, adding that it will manage the rate policy by making price stability firmer.

“Amid rising demand-pull inflationary pressure, the country’s consumer prices will be under mounting upward pressure from the supply side like gains in prices of raw materials and agricultural products,” Kim said in a press conference.

“Consumer inflation is likely to grow in the mid- to upper-3 percent range in the first half ... The rate hike aims to help curb rising inflation expectations.”

Affected by the rate hike, the local currency rose 0.47 percent to close at 1,114.20 won against the dollar. The prices of government bonds declined with the March Treasury bond futures falling by as much as 51 ticks at one point.

The hike, however, had limited impact on the benchmark Korea Composite Stock Price Index that retreated 5.47 points to 2,089.48.

The KOSPI touched a new record high at one point during the morning session, rising as much as 0.69 percent as eased fears about a debt-laden Europe emboldened investors to bet on risks.

The key index, however, pared gains after the Bank of Korea made a surprise announcement that it raised the base rate by a quarter percentage point amid mounting inflationary pressure.

“The rate hike did play a role of trimming the gains, but it was not a shock to the market,” said Kwak Joong-bo, a market analyst at Samsung Securities Co.

“It helped banks and insurers to rebound from recent losses.”

Korea is grappling with growing risks of higher inflation as relatively strong economic growth and rising oil and grain prices are exerting upward pressure on the country’s consumer prices.

Mindful of concerns that price instability would undercut the growth momentum, President Lee Myung-bak has declared a “war” on inflation, and the government earlier in the day unveiled a set of anti-inflationary measures, including a freeze in college tuition and public utility charges.

“A mixture of microeconomic and macroeconomic policies are expected to help tame inflationary pressure,” Kim said.

January’s rate increase is widely expected to lend support to the government’s drive to rein in inflation experts say. Finance Minister Yoon Jeung-hyun said the government will sternly tackle price instability as the country is expected to face unfavorable inflation conditions this year.

The BOK forecast inflation to grow 3.5 percent this year, up from 2.9 percent in 2010. But the government vowed to contain consumer inflation at around 3 percent this year, while achieving about 5 percent economic growth.

The central bank aims to keep the median inflation target at 3 percent with a margin of plus or minus 1 percentage point for 2010-2012.

“The BOK has been quite behind the curve in raising the rate. But concerns about growing inflation risks seemed to lead the central bank to act this month,” said Oh Suk-tae, a senior economist at SC First Bank. “The bank is likely to raise the rate again within three months.”

Analysts said the BOK is forecast to continue to raise the rate this year as the bank’s 2011 policy direction indicated, but the process of the policy normalization would depend on external economic conditions.

Experts say keeping price stability is needed as still-low borrowing costs are feared to spark asset bubbles and to further increase households’ debt, which has already stayed at a high level.

“The BOK is expected to gauge the effect of January’s rate hike before the next move. It will closely watch economic and financial conditions like the eurozone debt crisis at home and abroad,” said Lee Sung-kwon, a senior economist at Shinhan Investment Corp.

Yum Sang-hoon, a fixed-income analyst at SK Securities, said that a potential rate hike may come in March or April as consumer inflation is feared to grow near 4 percent in the first quarter.

(From news reports)