The Bank of Korea said its seven policymakers cut the benchmark seven-day repurchase rate by a quarter of a percentage point to 3 per cent. The decision mirrors similar moves by policymakers in Europe and China but came surprised most market watchers, who forecast a rate freeze.
"We expect the rate cut will help the South Korean economy return to a long-term growth trend," said Kim Choong-soo, Bank of Korea governor, at a press conference.
The central bank said some economic indicators in the U.S. have shown signs of deteriorating and the sluggishness of economic activities in the euro currency area has deepened. Economic growth in South Korea will be weaker than previously expected as exports and domestic demand, two key growth engines, both remain at a low level.
"Going forward the committee expects the pace of global economic recovery to be more moderate than originally forecast, and judges the downside risks to growth to be intensifying further," the monetary policy committee said in a statement.
South Korea's government cut the country's 2012 growth outlook to 3.3 per cent from 3.7 per cent last month, as weakening demand in Europe and China is feared to dent South Korea's exports.
The Bank of Korea is scheduled to release its forecast on the South Korean economy Friday.
The July rate cut was South Korea's first since February 2009, when the central bank lowered its policy rate by 50 basis points to a record low of 2 per cent. The bank raised key interest rates in five steps between July 2010 and June 2011 to 3.25 per cent.
The bank had refrained from raising its policy rate for more than a year because of worries about the global economic uncertainty. High inflationary pressure gave the central bank little room to stimulate the economy through monetary easing.
In June, growth in consumer prices eased to a 32-month low of 2.2 per cent, below the Bank of Korea's median inflation target of 3 per cent. That gave policymakers room to buoy economic growth without worrying about stoking inflation.
The Bank of Korea governor said the rate hike will not affect consumer prices this year, and that its impact will be negligible on the next year's consumer price index, a benchmark gauge for inflation.
South Korea joins global central banks in monetary easing. Last week, the European Central Bank cut its key interest rate by a quarter of a percentage point to a record low in an effort to boost its sagging economy and China's central bank also lowered its key interest rate for a second time in a month.