South Korea holds rates as political scandal, hawkish Fed put c.bank in bind

By Christine Kim and Cynthia Kim

SEOUL (Reuters) - South Korea's central bank held its key policy rate steady at a record low of 1.25 percent on Thursday, as authorities sit tight in the face of a political crisis at home and the U.S. Federal Reserve's signal to raise rates at a faster-than-expected pace.

The Bank of Korea flagged growing risks for the export-reliant economy that some analysts feel should be tempered through another rate cut, but the BOK faces a dilemma as further easing could spark destabilising capital flows toward higher yielding U.S. dollar-based assets.

"There is a risk that cutting interest rates at a time when the Fed is in the middle of a tightening cycle could lead to disruptive capital outflows," said Krystal Tan, Asia economist at Capital Economics.

The Fed's rate rise of 25 basis points to 0.50-0.75 percent was well flagged but the "dot plots" of Federal Open Market Committee members' projections showed a median of three hikes next year, up from two previously, leaving investors scrambling to adjust positions.

That meant the rate gap between the United States and Korea will continue to narrow, making another BOK cut an unpalatable prospect given the risks of capital outflows.

BOK Governor Lee Ju-yeol, however, took pains to underscore that the Fed wasn't the lone factor in its policy deliberations.

"I have repeatedly said this but we look at the entire picture of the economy, and not just the Fed," Lee told reporters soon after the rates were held steady for the sixth month in a row.

POLITICAL RISKS, TRUMP FACTOR

Risks at home have grown as a political crisis has embroiled President Park Geun-hye and raised fresh risks for Asia's fourth-biggest economy.

Lee declined to say whether the Park scandal was a bigger risk to the economy than offshore headwinds, but emphasised that policymakers will be focused on improving gloomy sentiment.

Park looks set to lose her job after lawmakers overwhelmingly voted to impeach her last week over an influence-peddling scandal.

The Park scandal has threatened to derail many investment and business decisions at conglomerates, especially as a parliament probe has ensnared leaders of companies from Samsung Electronics to Lotte Group to SK Group.

"Political uncertainties seem to be a bigger risk here for companies than external factors related to Fed's policies and Trump administration," Park Sang-hyun, an economist at HI Investment & Securities said.

"The BOK will stay on hold throughout 2017 due to such political uncertainties and household debt."

South Korea's economic recovery has stuttered over the past two years in the face of slack global demand and tepid private consumption.

The collapse of Hanjin Shipping Co Ltd, and a fire-prone smartphone being cancelled at Samsung Electronics Co Ltd have put additional strain on growth.

U.S. President-elect Donald Trump also poses a risk for Korea, especially if his campaign protectionist rhetoric finds policy traction - derailing South Korea's exports which have only recently started to find their footing.

South Korea in recent months has seen a spike in capital outflows on expectations of higher interest rates in the U.S. and Trump's election upset, drawing a quick response from Seoul to act to stabilise any market disruptions.

Offshore investors reduced their bond holdings by a net 1.798 trillion won ($1.54 billion) in November, offloading for a fourth month in a row.

(Editing by Shri Navaratnam)