South Korea raised interest rates on Thursday, surprising markets, and unveiled a set of measures to contain mounting inflation as policymakers around the world battle surging prices of food and other commodities.

Bond prices fell as the surprise move prompted traders to price in more tightening by the central back this year than they had earlier expected.

Analysts surveyed later by Reuters said they now see the central bank delivering four rate increases in 2011 totaling 100 basis points (bps), including the one on Thursday. That is 25 bps more than they had predicted in a poll in December.

President Lee Myung-bak, who last week declared a war on inflation, on Thursday ordered a review of fuel oil prices in a gesture aimed at discouraging domestic companies from raising prices as international crude oil prices neared $100 a barrel.

Bank of Korea Governor Kim Choong-soo said inflationary pressures were building faster than it had expected a month ago, while Finance Minister Yoon Jeung-hyun said stabilizing inflation was the top economic policy priority. Upward price pressures and inflation expectations have been increasing. Therefore, the committee judges it is important to contain them at current levels, Kim told reporters.

There is a substantial amount of liquidity left in the course of overcoming the global crisis. It will be the key task for the future monetary policy how to deal with it.

The benchmark 7-day repurchase agreement rate was raised by 25 bps to 2.75 percent, marking the third hike since the end of the 2007-2008 global financial crisis and moving closer to 3.25 percent seen before the crisis. Government bond prices fell, with more liquid 3-year paper hit especially hard. The 3-year yield rose 10 bps to 3.64 percent while the 1-year yield gained 8 bps to 3.0 percent. Stocks <.KS11> and the won showed a muted reaction. Analysts said the next rise could come as early as in March. I expect the next raise to come in March after pausing in February, when there's a Lunar New Year holiday, said Park Tae-keun, fixed-income analyst at Hanwha Securities, adding he was raising his view for the rate at the end of the year to 3.5 percent from 3.25 percent previously.

The median forecast from the survey was for the benchmark interest rate to end the year at 3.5 percent, up from 3.25 percent seen in a previous Reuters survey in December. The government said separately it would cut import tariffs this month on items such as fish and powdered milk, freeze government-controlled prices such as electricity tariffs and rail transportation fares, and toughen punishment on pricing irregularities.

In case of oil prices, which influence prices of many other products, I see the need for a thorough review of the trends in crude prices and foreign exchange rates to find out if the current prices were appropriate, a statement by the presidential office quoted President Lee as telling senior officials.

He also ordered the government to draw up steps to boost stocks of grain, for which the country relies heavily on imports. Analysts said the measures would help ease public worries about rising prices to some degree, although any immediate and direct impact on the overall inflation rate would be limited. The Bank of Korea in December forecast consumer inflation would pick up to 3.5 percent this year from last year's 2.9 percent, but analysts see the 2011 reading topping 4 percent, or the upper end of the central bank's target of 2-4 percent.

(Editing by Jacqueline Wong & Kim Coghill)

South Korea Inflation