South Korea says North torpedoed ship, tensions rise

SEOUL (Reuters) - South Korea accused the reclusive North on Thursday of torpedoing one of its warships, heightening tensions in the region and drawing a warning from the United States that Pyongyang must face consequences.

Jittery South Korean financial markets and its currency fell as Seoul vowed to take "firm" measures against its neighbour. Pyongyang, furiously denying the charge, warned it was ready for war if fresh sanctions were imposed.

The United States, which has some 28,000 troops stationed in the South following the 1950-53 Korean War, said it stood ready to help South Korea defend itself against any further "acts of aggression.

Amid international condemnation of North Korea, the impoverished country's only major ally, China, said it would make its own assessment of the South Korean investigation.

Mindful of the tension on the Korean peninsula, U.S. Defence Secretary Robert Gates and spokesmen for the White House and the State Department chose their words carefully in their responses to the report.

"Clearly this was a serious provocation by North Korea and there will definitely be consequences because of what North Korea has done," said State Department spokesman P.J. Crowley.

Gates said the United States was consulting with South Korea, which would decide what action to take.

A report by investigators, including experts from the United States, Australia, Britain and Sweden, concluded that a North Korean submarine had fired the torpedo that sank the Cheonan corvette in March, killing 46 sailors.

FINANCIAL MARKET FALLOUT

The escalating tension weighed on South Korean financial markets, already worried that investors jumpy about global financial concerns may pull out their money.

The South Korean won suffered its biggest daily fall against the dollar in 10 months. Stocks closed at their lowest level in almost three months.

U.N. Secretary-General Ban Ki-moon called the result of the South Korean investigation deeply troubling.

Envoys at the United Nations suggested the issue could come before the Security Council early next week if Seoul requested that the 15-nation body discuss it.

President Barack Obama's administration was consulting with South Korea's neighbours and the U.N. Security Council on what to do next, said White House spokesman Robert Gibbs.

Japan said it would be difficult to resume nuclear disarmament talks between five regional powers and the North, and said Washington shared its view that such negotiations, aimed at aiding Pyongyang in return for a promise to drop its nuclear arms, were unthinkable.

Chinese Foreign Ministry spokesman Ma Zhaoxu urged both sides on the divided Korean peninsula to exercise restraint.

China, a veto-wielding member of the United Nations Security Council, could derail any efforts to impose tougher sanctions on Pyongyang. Its hesitance to echo the international condemnation of the North could also complicate U.S. diplomatic efforts towards Beijing.

South Korean President Lee Myung-bak will hold an emergency meeting of his National Security Council on Friday. His government has made clear it has no plans for a retaliatory strike but will press the international community to take action, probably more sanctions, against the North.

"We will be taking firm, responsive measures against the North, and through international cooperation, we have to make the North admit its wrongdoing and come back as a responsible member of the international community," Lee was quoted by his office as telling Australian Prime Minister Kevin Rudd.

The South Korean report said intelligence had shown that North Korean submarines were likely operating near the scene of the sinking.

"The evidence points overwhelmingly to the conclusion that the torpedo was fired by a North Korean submarine," it said.

North Korea said the South's conservative government was using the incident for political gain.

"Our army and people will promptly react to any 'punishment' and 'retaliation' and to any 'sanctions' infringing upon our state interests with various forms of tough measures including an all-out war," the North's official news agency quoted the powerful National Defence Commission as saying.

(Additional reporting by Rhee So-eui, Miyoung Kim, Christine Kim and Kim Yeon-hee in SEOUL, Chris Buckley in BEIJING, Paul Eckert, Matt Spetalnick, David Alexander in WASHINGTON, Patrick Worsnip in NEW YORK; Writing by Jonathan Thatcher and Ross Colvin; Editing by Chris Wilson)