The Bank of Korea lowered its economic growth forecast for this year on an expected slowdown in domestic demand, while raising the projection of inflation to its target limit.

South Korea’s economy will expand 4.3 percent, compared with the 4.5 percent growth estimated in April, the central bank said today in a statement. Consumer prices are expected to rise 4 percent, higher than the earlier 3.9 percent gain forecast.

The Bank of Korea board’s unanimous decision to hold interest rates steady yesterday reflected policy makers’ concern about Europe’s sovereign debt crisis, Governor Kim Choong Soo said. Still, with inflation overshooting the central bank’s 4 percent target limit every month so far this year, the bank will probably increase borrowing costs twice more in 2011, according to the median forecast of economists in a Bloomberg News survey.

“If risks to growth loom larger, the central bank may pause again next month,” Kong Dong Rak, a fixed-income analyst at Taurus Investment & Securities Co. in Seoul, said before the announcement. “They may wait until the dust over Europe and the U.S. is settled a bit more.”

Prices have been rising on surging food costs, increasing demand due to economic growth and inflation expectations, the Bank of Korea said yesterday.

‘Downside Risks’

“High prices are damping domestic consumption and construction investment is too weak,” Lee Sang Woo, director- general of the Bank of Korea’s research department, told reporters today. “We see greater downside risks to growth, given the possibility that the sovereign debt problems in the euro area may spread and the U.S. may recover at a slower pace.”

The Bank of Korea said today it expects inflation to slow to 3.5 percent in the fourth quarter after a 4.2 percent rate in both the second and third quarters, as accelerating price gains in the last quarter of 2010 affected the year-on-year comparison.

It forecasts economic growth of 5.2 percent in the fourth quarter following a 4.2 percent expansion in the third quarter and a 3.5 percent increase in the second quarter.

The Finance Ministry on June 30 raised this year’s inflation forecast to 4 percent from 3 percent while slashing its growth projection to 4.5 percent from 5 percent.

Next year, economic growth will likely accelerate to 4.6 percent while inflation will moderate to 3.4 percent, the central bank said. Core prices, excluding food and energy, will rise 3.5 percent this year and 3.7 percent next year.

Current-Account Surplus

The current-account surplus is expected to widen to $17 billion in 2012 from $15.5 billion this year. Unemployment will likely fall to 3.4 percent next year from 3.5 percent this year, the Bank of Korea said.

The Bank of Korea kept the benchmark seven-day repurchase rate at 3.25 percent yesterday. Seven out of eight analysts expect the central bank to raise its benchmark rate to 3.5 percent during the current quarter, and six out of the eight forecast a further increase to 3.75 percent in the fourth quarter, according to a survey by Bloomberg News.

Bloomberg