South Korea's manufacturing sector shrank the most in nearly three years in December as global demand cooled, a survey showed on Monday, but President Lee Myung-bak cited inflation as a bigger risk in a year of big elections.

Lee admitted in a televised new year speech that the global economy has entered a period of prolonged low growth but said fighting rising prices was still his top policy priority as the poor suffer from high living costs.

The waves (of economic difficulty) will likely be much higher this year. The global economy is not in a temporary slump but has entered a new era of low growth, Lee said, adding the government would bring down inflation close to 3 percent.

Investors shrugged off Lee's comments as they thought developments in the euro zone's fiscal crisis would continue to dominate global as well as local markets well into the new year.

South Korea's inflation jumped to 4.0 percent in 2011 on an annual average basis, touching the second highest in 10 years, from 3.0 percent in 2010 on high commodities prices and price rises following the fast economic recovery since late 2009.

The popularity of Lee's conservative Grand National Party is falling amid a public outcry over the widening wealth divide, high prices and disappointing job growth.

The country is due to hold two nationwide elections this year.

Lee will step down at the end of his five-year term in early 2013 and is barred by the constitution from running for a second term.

The comments came as the HSBC/Markit survey showed the purchasing managers' index (PMI) on South Korea's manufacturing sector fell to a seasonally adjusted 46.40 in December from 47.12 in November, hitting the lowest level since February 2009.

It was the fifth month in a row that the index stayed below 50 demarcating expansion from contraction in manufacturing activity, the longest such losing streak since February 2009.

A sharper drop in manufacturing activity over December confirms that Korea's economy is losing steam, with employment contracting over the month for the first time in almost three years, HSBC economist Ronald Man said in a statement.

He was referring to the first fall below 50 of the sub-index on employment in the manufacturing sector since February 2009, when the world was recovering from the shock of the worst economic crisis in decades.

The sub-index on employment fell to a seasonally adjusted 49.37 in December from 50.50 in November.

Similar manufacturing reports showed activity continued to contract in December in other parts of Asia as well, with China's factories struggling and Taiwan's PMI falling for a seventh straight month, even as the U.S. economy shows signs of gaining momentum.

The sub-index on new export orders received by South Korean manufacturers fell to a seasonally adjusted 45.96 in December, the lowest since early 2009 and also coming below the 50-point mark for a fifth consecutive month.

In turn, policy makers should act pre-emptively to support the economy, and we expect the Bank of Korea to deliver a 25 basis-point cut in the first quarter of 2012, said Man, referring to the central bank's interest rate policy.

The Bank of Korea downgraded its outlook for Asia's fourth-largest economy in December but maintained its policy priority on fighting inflation, although analysts are increasingly predicting a rate cut later this year.

(Editing by Jonathan Hopfner & Kim Coghill)

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