South Korea's central bank has raised its benchmark interest rate for the second consecutive meeting, taking action to curb inflation risks stemming from economic growth that has exceeded expectations, driven by an unprecedented semiconductor industry boom. The Korean won edged higher, extending gains made ahead of the policy decision.

On Thursday, the Bank of Korea voted 6 to 1 to lift the seven-day repurchase rate by 25 basis points to 3%, with the sole dissenting member advocating for holding rates steady. A prior survey of 22 economists had shown 14 predicting the quarter-point hike, while eight expected no change. The central bank had already raised rates by 25 basis points in July, marking its first increase since January 2023.

Rare Back-to-Back Tightening Move

The Bank of Korea seldom raises borrowing costs in consecutive meetings. The last instance of back-to-back hikes occurred in early 2023. Prior to that, the central bank delivered consecutive increases in the summer of 2007 and during the winter of 2021-2022.

AI Infrastructure Frenzy Fuels Chip Boom, Growth Forecasts Revised Sharply Higher

The rate decision comes as South Korea's export-driven economy flourishes, underpinned by robust semiconductor demand driven by the global AI infrastructure buildout. Alongside the monetary tightening, the central bank significantly raised its growth projections for this year and next. It now expects gross domestic product to expand 3.3% in the current year, a substantial upgrade from the 2.6% forecast previously issued, with 2027 growth projected at 2.9%.

Jeong-Woo Park, an economist at Nomura Holdings, noted that with next year's growth forecast at 2.9%, the central bank had no reason to hesitate. He suggested policymakers are likely more optimistic about domestic consumption and construction activity next year, supported by government fiscal spending favoring the construction sector, while the central bank governor has indicated that higher gross national income will drive consumption. Park had anticipated Thursday's 25 basis point hike.

Economist Hyosung Kwon commented that the rate increase aims to limit the spillover of income growth into demand-driven inflation and to curb financial imbalances. Kwon added that the policy rate is still expected to reach 3.5% by the first half of 2027.

Dot Plot Signals Further Tightening, Inflation Remains Key Policy Driver

The Bank of Korea also released an updated dot plot, the first since May, showing policy board members' projections for the benchmark rate six months out. All seven monetary policy committee members, including Governor Rhee Chang-yong, submit their rate forecasts anonymously, with each providing three points for baseline, upside, and downside scenarios, totaling 21 points. The latest dot plot shows 10 of the 21 points clustered at 3.25%, hinting at the possibility of additional hikes.

Updated Forward Guidance

In a statement, the central bank committee said inflation is expected to remain above its target level for a considerable period and that it will continue to implement policy to bring price growth in line with the target. The Bank of Korea maintains its forecast for consumer inflation of 2.7% this year and 2.3% in 2027.

Following the decision, the Korean won strengthened to as high as 1,377.40 per dollar. Since the July meeting, the currency had breached the 1,400 level and previously touched 1,562 in June, marking a 17-year low. The won has rebounded recently, yet the central bank's decision to hike again underscores its resolve to address inflation risks.

Recent economic data also supports the move. South Korea's economy grew 0.6% quarter-on-quarter in the second quarter, well above the 0.2% pace the central bank had projected in May, with year-on-year growth at 3.7%. Inflation has remained at or above the central bank's 2% target for nearly a year. Consumer prices rose 2.8% year-on-year in July, slowing from June's 3.2%, but underlying price pressures persist, with core inflation, excluding food and energy, at 2.6%.

At a post-meeting press conference, central bank Governor Shin Hyun-sung stated that the chip industry boom and improving incomes will support economic growth, adding that inflation remains the most important factor in interest rate decisions.