The Bank of Korea said its 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 to stave off a recession but surprised most market watchers, who had forecast a rate freeze for a 13th straight month. The rate cut decision among seven policymakers was not unanimous.
"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.
Without lowering borrowing costs that would boost spending among businesses and consumers, policymakers believed the actual growth in South Korea was expected to lag behind its potential, Kim added.
The central bank said that some economic indicators in the U.S. have shown signs of deterioration and that the sluggishness of economic activities in the euro zone 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 low levels.
"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 joins other 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. China's central bank also lowered its key interest rate for the second time in a month.
South Korea's electronics and automaking exporters are bracing for weak demand overseas for the rest of the year. Samsung Electronics Co., the world's largest maker of televisions, mobile phones and memory chips, reported last week that its second-quarter sales fell short of market expectations.
South Korea' finance ministry said in June that it expected the economy to expand 3.3 per cent this year from 2011, below an earlier forecast of 3.7 per cent.
The Bank of Korea is scheduled to release its forecast on the economy on Friday.
Market analysts said the Bank of Korea is likely to further ease its monetary policy ahead of December presidential elections as its focus now seems to have moved to growth over price stability.
"The governor said lower interest rates will ease burden from household debts. He also said the country's output growth is expected to stay below its potential for a while," said analyst Yoon Yeo-sam of Daewoo Securities. "So there is an increased chance of additional rate cut."
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 in the wake of global financial turmoil. The bank raised key interest rates in five steps between July 2010 and June 2011 to 3.25 per cent, as low borrowing costs built up inflationary pressure.
The central bank had refrained from raising its policy rate for more than a year because worries about global economic uncertainty re-emerged with escalating public debts in Europe. But stubbornly high inflationary pressure left 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 would not affect consumer prices this year, and that its impact would be negligible on the next year's consumer price index, a benchmark gauge for inflation.
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