Semiconductor boom intensifies inflation risk as Bank of Korea raises interest rates twice in a row

According to Zhitong Finance APP, the Bank of Korea has raised its benchmark interest rate for the second consecutive time to address inflation risks triggered by unprecedented growth in the semiconductor industry, which has propelled the economy to exceed expectations. The Korean won rose slightly, extending its gains from before the rate decision was announced.

On Thursday, South Korea raised its seven-day repo rate by 25 basis points to 3% with a 6-to-1 vote; the only dissenting committee member supported holding rates steady. In a previous survey of 22 economists, 14 expected a 25 basis point hike, while 8 expected rates to remain unchanged. The Bank of Korea had raised rates by 25 basis points in July, the first hike since January 2023.

Rare 'Back-to-Back' Hikes by the Bank of Korea

The Bank of Korea seldom raises borrowing costs consecutively. The last back-to-back hike was in early 2023. Before that, it had conducted consecutive increases in the summer of 2007 and the winter of 2021–2022.

AI Infrastructure Boom Sparks Semiconductor Prosperity; Bank of Korea Significantly Upgrades Economic Growth Forecast

The Bank of Korea announced its latest rate decision as the country’s export-driven economy thrives, mainly fueled by a global AI infrastructure boom that is driving robust demand for semiconductors. In addition to tightening monetary policy, the Bank of Korea also significantly raised its economic growth forecasts for this year and next. This year’s Gross Domestic Product (GDP) is now expected to grow by 3.3%, up sharply from a previous 2.6%; GDP for 2027 is projected to grow by 2.9%.

Nomura Holdings economist Jeong-Woo Park stated: "Given the 2.9% economic growth estimate for next year, the Bank of Korea has no reason to hesitate. They are likely more optimistic about domestic consumption and the construction sector next year. Government fiscal spending also tends to support the construction industry, and the Bank of Korea governor has stated that higher gross national income will boost consumption." Park had previously expected the Bank of Korea to hike by 25 basis points this Thursday.

Economist Hyosung Kwon commented: "The rate hike aims to limit the spillover effect of income growth on demand-driven inflation and curb financial imbalances. We still expect the policy rate to reach 3.5% in the first half of 2027.”

Dot Plot Signals Hike Cycle Not Over; Inflation Remains Core Variable for Monetary Policy

The Bank of Korea also released its first updated “dot plot” since May, indicating Monetary Policy Committee members’ forecasts for the benchmark rate six months ahead. All seven members, including Governor Rhee Chang-yong, anonymously submitted their rate forecasts: each provided three dots—baseline, upside, and downside scenarios—for a total of 21 dots.

The latest dot plot shows that 10 out of the 21 dots are clustered at 3.25%, suggesting another rate hike may occur.

Latest Forward Guidance

In a statement, the Bank of Korea committee said it expects inflation to remain above target for an extended period and will continue to implement policies to align price increases with its target. The Bank of Korea still expects this year’s consumer inflation rate at 2.7%, and 2.3% in 2027.

After the decision was announced, the Korean won briefly strengthened to 1,377.40 against the US dollar. Since the July meeting, the won had breached the 1,400 mark against the dollar; in June, it touched 1,562, the lowest level in 17 years. The won has rebounded recently, but the Bank of Korea's decision to hike again underscores its resolve to address inflation risks.

The latest economic data also support the Bank of Korea’s tightening stance. In Q2, the Korean economy grew by 0.6% quarter-on-quarter, far exceeding the Bank of Korea’s May projection of 0.2%. Year-on-year, the economy grew by 3.7%.

Over the past year, the inflation rate has consistently been at or above the Bank of Korea’s 2% target. In July, consumer prices rose 2.8% year-on-year, down from 3.2% in June, but underlying price pressures persist, with core inflation (excluding food and energy) at 2.6%.

Bank of Korea Governor Rhee Chang-yong stated at a post-meeting press conference that the semiconductor boom and improved incomes will support economic growth. He also said inflation remains the most crucial factor in the interest rate decision.