The Bank of Korea (BOK) left its benchmark interest rate unchanged at 3.25 percent on Thursday, keeping its rate freeze stance for nine straight months due to conflicting factors such as lingering downside risks to the economy and the possibly higher inflationary pressures amid rising oil prices.

Governor Kim Choong-soo and monetary policy board members decided unanimously to freeze the 7-day repo rate at 3.25 percent at the March rate-setting meeting. The BOK has lifted the borrowing costs by a total of 125 (bps) in five steps since July 2010.

"In the past, we presented chronic inflation expectations, the global economic recovery and the sustainable growth of local economy as three requirements for rate normalization, but it is hard to say that the global economy recovered now as the real economy has yet to recover," Kim told reporters after the March rate-setting meeting.

The governor noted that the central bank should take considerably all the effects of high oil prices on both economic growth and inflation, stressing that high oil prices tend to have a significant impact on the headline inflation.

The decision was in line with market expectations as experts predicted the rate freeze due to conflicting factors such as the remaining downside risks to the Asia's No.4 economy and the possible acceleration in inflationary pressures amid higher oil prices.

DOWNSIDE RISK

The BOK said in a statement that the country's economic growth has not slowed further, citing an expansion in exports, consumption and facilities investment. The bank also noted that unrest in the global financial market arising from the European fiscal crisis has eased.

The central bank, however, noted that external risk factors such as the sovereign debt problems in Europe and geopolitical risks in the Middle East still existed, saying that growth in emerging economies has continued to show signs of weakening due to slowing exports. The bank expected the downside risk factors to dominate the economy.

The South Korean economy saw some economic indicators improved on seasonal factors, but concerns remained over the downside risks to the economy. Output in the mining and manufacturing sectors unexpectedly grew 3.3 percent in January from a month earlier, but the industrial output dropped 2 percent on an on-year basis, the first decline in 31 months.

Exports, which account for more than half of the Asia's No.4 economy, recovered its growth trend in February, but it was mainly attributed to a one-off factor such as growing working days caused by the movement of the Lunar New Year holiday. The working-day adjusted, combined exports for the first two months of this year decline 0.7 percent on an on-year basis.

Market watchers forecast that the exports, a major engine for the export-driven economy, may slow further amid the ongoing fiscal crisis in Europe and the possible global economic downturn. "Given weaker underlying exports and upcoming negative base effects, we now expect exports to decline by 3.8 percent on-year in March," Kwon Young-sun, an economist at Nomura International in Hong Kong, said before the rate decision.

EXTERNAL UNCERTAINTY

Following a second round of liquidity injection by the European Central Bank (ECB), concerns over the region's fiscal crisis eased somewhat, but fiscal tightening in advanced economies would weigh on the global economic recovery, adding downside risks to the South Korean economy.

"South Korea's export momentum weakened significantly in January, with domestic demand remaining in the doldrums. Fiscal tightening is weighing on growth in developed countries," said Yoon Yeo-sam, a fixed-income analyst at Daewoo Securities.

Advanced economies, including the United States and Europe, will continue to be required to tighten fiscal expenditures. Eurozone member countries may have to cut their fiscal deficits below 3 percent of GDP under a new fiscal pact. Even if economic conditions deteriorate, the developed countries will have little room for fiscal stimulation.

INFLATIONARY PRESSURE

The country's consumer price inflation slowed to 3.1 percent in February, close to the midpoint of the BOK's inflation target band of 2-4 percent, but it was too early to lower the guard against inflation as inflation expectation, a gauge of future demand-side inflationary pressure, remained at a high level. Inflation expectation came in at an annual rate of 4 percent last month.

Supply-side inflationary pressures seemed set to materialize in the near future. Although the Western Texas Intermediate price was still hovering below 110 U.S. dollars a barrel, prices for Dubai crude, South Korea's benchmark topped 120 dollars a barrel recently.

According to the Korea National Oil Corp. (KNOC), Dubai crude prices averaged 105.98 dollars per barrel in 2011 due to social unrest in the MENA region, and the average price rose further to 113.91 dollars a barrel this year. "Based on the real purchasing power, oil prices are now at the levels prevalent during oil shocks in the 1970s. The likelihood of oil prices stabilizing in the near future is slim," said Yoon at Daewoo Securities.

Liquidity injection by major central banks also boosted inflationary pressures. The ECB allotted a total 529.5 billion euros (around 700 billion U.S. dollars) late last month through its second round of three-year long-term refinancing operation ( LTRO). The amount was up from 489 billion euros for the first round.

The U.S. Federal Reserve pledged to leave rates on hold until late-2014, and the Bank of England (BOE) expanded its asset purchase program by another 50 billion British pounds to a total of 325 billion pounds.