The Bank of Korea (BOK) raised the benchmark interest rate by 0.25 percentage points at the Monetary Policy Board of the Bank of Korea's monetary policy committee on Aug. 27. The benchmark rate returned to 3.0% annually for the first time in a year and six months since Feb. 2025. It was a back-to-back increase carried out right after the July hike, the first in three years and six months. The gap with the U.S. benchmark rate (upper bound) narrowed from 1 percentage point to 0.75 percentage points.
There have been only three instances when the Bank of Korea (BOK) went for back-to-back hikes: July–August 2007; November 2021–January 2022; and April 2022–January 2023. That makes this an unusual decision. The emergency step was taken because the semiconductor boom fueled by the artificial intelligence (AI) investment craze is increasingly likely to spill over into economy-wide income gains and stoke demand-pull inflation (price increases; hereafter, inflation).
In the revised economic outlook released the same day, the Bank of Korea (BOK) raised its forecasts for gross domestic product (GDP) growth in 2026 and 2027 from 2.6% and 2.1% in May to 3.3% and 2.9%. Compared with the February forecast (2.0%), that is an upward revision of 1.3 percentage points in six months.
By contrast, the forecast for this year's consumer price inflation was kept at 2.7%. The aim is to preemptively rein in inflationary pressure that the semiconductor boom could generate, rather than current prices. Bank of Korea (BOK) Governor Shin Hyun-song said, "It is important to prevent an expansion in price increases through preemptive action," adding, "We used a hoe rather than a plow for policy." Monetary Policy Board members suggested 3.25% as the median projection for the benchmark rate in six months, leaving the door open to another hike.
Faster "hoe" response than in 2007
This back-to-back hike resembles July–August 2007, when rates were raised in succession to prevent an economic upturn from leading to a surge in lending and an overheated real estate market. Back then, the hikes came after financial imbalances became pronounced; this time, rates were raised before the surge in income from the semiconductor boom could spread to consumption and the asset market.
Helped by a spike in memory chip prices, exports in the first half (January–June) jumped 48.4% from a year earlier (preliminary data from the Ministry of Trade, Industry and Resources), pushing the real gross domestic income (GDI) growth rate in the second quarter to 15.6%, the highest in 38 years. The gap with the quarter's 3.7% GDP growth rate was 11.9 percentage points. Considering that the average gap between the two indicators over the past 20 years was 0.14 percentage points, it shows how massive the income gains from the AI investment boom have been for the Korean economy.
The income boost from higher semiconductor prices first piles up as corporate profits, but with a lag it flows into domestic demand through wages and bonuses, capital spending, and tax revenue and fiscal outlays. Kwon Hyo-seong, an economist at Bloomberg Economics, said, "As large performance bonuses at semiconductor corporations and increased corporate tax receipts kick in next year, income growth outpacing production is likely to more clearly amplify demand-side inflationary pressure."
The Bank of Korea (BOK) assesses that inflationary pressure could be stronger in Korea than in Taiwan, where growth of 11% is forecast this year thanks to the AI boom. In Taiwan, AI demand boosts real GDP by increasing semiconductor and server output, whereas in Korea, where the AI windfall is concentrated in semiconductors, demand growth is more quickly pushing up prices, corporate profits, and national income than output. Lee Ji-ho, deputy governor of the Bank of Korea (BOK), said, "Taiwan's nominal wages are much lower than Korea's, and information technology (IT) accounts for a much larger share of its economy," adding, "There are more channels in Korea, where wages are higher, for demand-side inflationary pressure to emerge."
A growth tailwind becomes a trigger for tightening
The Bank of Korea (BOK)'s back-to-back rate hikes can be seen as an early case of the AI investment boom leading to tighter monetary policy. There are high expectations that AI, which boosts productivity and potential growth in the long run, will reduce inflationary pressure. But the effects seen so far are not productivity gains; they are an explosion in demand for memory chips from the race to build more data centers, supply bottlenecks, and soaring prices. As the AI boom brings inflation rather than disinflation (a slowdown in the inflation rate), the Central Bank has found itself needing to speed up rate hikes.
Expansionary fiscal policies in major countries to support AI investment deepen the Central Bank's dilemma. The Lee Jae-myung administration in Korea on Sept. 1 unveiled the 2027 government budget bill with total expenditure of 820.9 trillion won, up 12.8% from this year. That is an explosive budget growth rate, surpassing the 10.6% seen right after the global financial crisis in 2009. Moreover, under the National Fiscal Management Plan for 2026–2030, the average annual growth rate of total expenditure is set at 8.4%, with the 2030 budget to be increased to 1,005.2 trillion won.
Japan's Sanae Takaichi administration also plans "responsible active fiscal policy" that, along with a cut in the consumption tax on food, will induce a total of 370 trillion yen (about 3,182 trillion won) in public-private investment across 17 strategic fields by 2040. In that it aims to increase domestic production capacity and tax revenue at the same time through a tax cut and strategic industry investment, its direction resembles the U.S. Donald Trump administration's "One Big Beautiful Bill Act (OBBBA)."
The market strikes back with a rate tantrum
The more governments loosen fiscal policy to expand AI investment, the more the Central Bank may have to raise rates to curb inflation. This creates discordance, with fiscal policy pushing up demand and monetary policy restraining it.
Concerns over expansionary fiscal policy and prolonged inflation are showing up as a long-term rate tantrum in the global bond market. On Sept. 2 (local time hereafter), the U.S. 10-year Treasury yield topped 4.8% annually, the highest since November 2023. Japan's 10-year yield briefly exceeded 3% annually, rising to the highest level in 30 years since 1996. The U.K.'s 10-year and 30-year yields also hit their highest in 20 and 30 years, respectively. Korea's 10-year Treasury yield likewise broke above 4.4% annually, the highest in 15 years since 2011. As fiscal policies aimed at spreading the AI investment boom collide with monetary policy aimed at tamping down prices, a paradox has begun in which AI investment expenses are rising again.
Plus Point
Will the Fed raise rates before the U.S. midterms?
Can Chair Kevin Warsh of the U.S. Federal Reserve (Fed) raise the benchmark rate ahead of the November midterm elections?
In his Aug. 28 Jackson Hole speech, Warsh said, "If we are not confident that inflation is moving toward the target fast enough and clearly enough, we have work to do," leaving the door open to a rate hike. After the speech, the market-implied probability of a September hike jumped from around 35% to nearly 60%. Federal Reserve Governor Michael Barr also said on Sept. 1, "If inflation is not easing sufficiently, we must raise rates decisively." With growth and employment stable on the back of AI investment, the judgment is that there is room to tighten.
There is pushback. Mohamed El-Erian, chief economic adviser at Allianz, noted, "Inflation expectations are anchored, and while the demand-boosting effect of AI may be weakening, the supply effect of lifting productivity could grow," adding, "The market's view of the probability of a rate hike is excessively high."
U.S. President Donald Trump said Warsh will "do what needs to be done," but argued that "the United States should have the lowest interest rates in the world." The Financial Times (FT) projected that the White House, which wants low rates ahead of the midterms, could clash with the Fed, which wants to curb inflation. Some, however, say that a rate hike at the Federal Open Market Committee (FOMC) in September could help bring down long-term rates, which U.S. Treasury Secretary Scott Bessent is aiming for.