AI boom raises inflation stickiness, Bank of Korea implements rate hike, KOSPI plunges 7% triggering eighth circuit breaker of the year.

July 16, the Bank of Korea announced an increase in the 7-day repo rate from 2.50% to 2.75%, with all seven monetary policy committee members unanimously voting to raise rates by 25 basis points. This marks the first rate hike since January 2023 and signals the start of a new tightening cycle. The rate hike was fully in line with market expectations. Prior surveys by Bloomberg and Reuters showed all economists except one predicted a July rate increase. A poll by the Korea Financial Investment Association showed 66% of 100 fixed income specialists expected a rate hike this month. The increase from 2.50% to 2.75% may seem mild on its face, but its signaling effect far outweighs the numbers. Since October 2024, the Bank of Korea has cut rates four times, totaling a 100 basis point reduction, followed by eight consecutive freezes. This hike may mark the official end of the easing cycle. Bloomberg noted this move signals the start of a new policy cycle. The Bank of Korea clearly stated in its announcement, "It is deemed necessary to maintain a policy stance consistent with further rate hikes" and will "evaluate the extent of inflationary pressure, domestic economic improvement, and financial stability" to determine the timing and pace of future hikes. **Triple Pressure Converges, Bank of Korea Has 'No Choice'** Three drivers pushed for the rate hike, all pointing strongly in the same direction. As Governor Shin Hyun-Song put it, inflation, economic growth, exchange rate, and financial stability risks "all point in the same policy direction, minimizing the usual trade-offs that complicate monetary policy decisions." **Inflation is the most direct catalyst.** Korea’s June CPI rose 3.2% year-on-year, the fastest pace since December 2023, and topped 3% for two consecutive months. Xinhua reported Korea's oil-related product prices surged 24.7% in June, pushing overall inflation up by 0.93 percentage points. Core CPI rose from 2.0% at the start of the year to 2.5%, indicating underlying price pressures are spreading from the supply side to the demand side. **Economic growth provides room for rate hikes.** Q1 GDP grew 1.8% quarter-on-quarter, the fastest pace in five and a half years. June exports reached $102.25 billion, up 70.9% year-on-year, breaking the $100 billion mark for the first time. Semiconductor exports jumped 199.5% year-on-year to $44.82 billion, hitting a historic high. The BoK statement said, "This year's economic growth rate is expected to far exceed the 2.6% forecast in May." Earlier this week, the government raised the 2026 growth forecast by 1 percentage point to 3.0%. **Financial stability risk is the third pressure.** Xinhua reported that by the end of June, Korean household bank loans reached 1,189.4 trillion KRW (about $796.2 billion), up 7.6 trillion KRW month-on-month, marking the fourth consecutive monthly rise. Seoul metropolitan area housing prices have risen for 75 weeks straight. Bank of Korea materials submitted to parliament show that a 25 basis point rate increase would raise housing-related loan borrowers’ annual interest payments by 1.8 trillion KRW. The won has depreciated about 4% against the dollar so far this year, and in June fell to its lowest level since 2009. Reuters noted the weaker won adds to import price pressures. The Fed kept U.S. rates at 3.50%-3.75% in June, further widening the Korea-U.S. rate gap and pressure on the won’s depreciation. **"Systemic Impact of Stock Market Pullback Is Limited"** Governor Shin Hyun-Song’s statements at the press conference are key for market expectations on future tightening. On inflation—he said, "Consumer inflation will remain above target," "inflation will stay high for quite some time." The BoK expects core inflation may be slightly above the previously forecast 2.4%. On economic growth—"Data since the last BoK rate decision shows growth stronger than expected," "**AI’s strong development is the main driver of economic growth**." He also said the BoK might raise its growth forecast in the August revision period. On the won—"Although recently stabilized, the won remains weak," "expect won weakness to continue raising inflation for some time." On policy path—"We will continue to adjust policy until we are confident inflation and growth are sustainably near target." He added, at the next policy meeting on August 27, "all policy options will remain on the table." On stock market—"Systemic impact of the stock market pullback is limited." Context: KOSPI has fallen about 26% from its June peak, entering technical bear market. Shin also made an intriguing remark: "I care more about chip prices than chipmaker stock prices." Against the backdrop of a single-day KOSPI drop of 7%, this stance means the central bank focuses more on the real economy and inflation transmission, not asset price volatility. **KOSPI Plunges 6.90%, Circuit Breaker Triggered for Eighth Time This Year** After the rate hike announcement, the Korean stock market plummeted. Reuters reported the KOSPI index fell 502.44 points, down 6.90%, closing at 6781.97, wiping out the previous day's gains. The Korea Exchange launched the "SIDECAR" mechanism to pause KOSPI algorithmic trading. This was the eighth circuit breaker this year, and the 37th time the sidecar mechanism was initiated (including buying/selling sides). The last circuit breaker had occurred just three days prior, July 13, when the KOSPI fell over 8% intraday below 6900, triggering a Level 1 circuit breaker and suspending trading for 20 minutes—the seventh such occurrence since 2026. Tech heavyweights were hit hardest. SK Hynix plunged 11.7%, Samsung Electronics fell 8.9%. Combined, they make up more than half the KOSPI’s weight, directly determining the index’s direction. Battery maker LG Energy Solution rose 1.79%, Hyundai Motor fell 2.30%, Kia rose 0.69%. Foreign capital continued to exit. On the day, net foreign selling reached 7.768 trillion KRW. As previously reported by Wallstreetcn, net foreign selling in KOSPI reached 148 trillion KRW in H1 this year. Despite the deep recent correction, KOSPI is still up about 62% year-to-date, making it one of the best-performing indices globally. Reuters pointed this out to show there was inevitably a large correction after the big rally. Bond market reaction was milder. Reuters reported the 3-year Korean government bond yield fell 0.1 basis points to 3.858%, while the 10-year rose 1.9 basis points to 4.332%. Won response was limited. After the rate hike, the won traded at 1487.6 to the dollar, slightly below the previous nine-week high of 1483.9. **It’s Not Just About the Rate Hike: The Spiral Effect of Leveraged ETFs** Blaming the stock market plunge solely on the rate hike is clearly inaccurate. Multiple domestic and international media analyses point to a structural issue—leveraged ETFs. A July 9 Wallstreetcn article reported that at the end of May this year, 14 double-leveraged single-stock ETFs tracking Samsung Electronics and SK Hynix were listed. On July 7, all 14 products plunged 12%-13%; 13 fell below their issue price. On that day, the total turnover of the 16 single-stock leveraged and inverse ETFs reached 13.1 trillion KRW, over a third of all ETF turnover in the market. The mechanism of these products determines their amplification effect: at daily rebalancing, if the underlying stock falls, leveraged ETFs must sell more to maintain their ratio, creating a "down-sell-down" spiral. With Samsung and SK Hynix making up over half of KOSPI’s market cap, this mechanism adds extra downward pressure when the index falls. The Bank of Korea’s own attitude shifted in ten days. At the end of June in its Financial Stability Report, it judged the impact of single-stock leveraged ETFs on the market to be "limited." By mid-July, its written reply to parliament stated: with Samsung Electronics and SK Hynix accounting for over half of KOSPI’s weight, single-stock leveraged ETFs "may intensify concentration in certain stocks," and "can amplify market volatility through redemptions and position rebalancing during price adjustments." Regulators are taking action. President Lee Jae-myung stated Wednesday that controversy around leveraged ETFs is heating up and urged the Financial Supervisory Service and Korea Exchange to "deal with the issue swiftly." FSC Chairman Lee Eok-won said supplementary measures for single-stock leveraged ETFs will be announced soon. The securities industry has reached a consensus to raise the minimum margin for single-stock leveraged ETFs from 10 million KRW to 50 million KRW. On July 16, Korea’s four major economic agencies—Ministry of Planning and Finance, Financial Services Commission, Bank of Korea, and Financial Supervisory Service—held a joint meeting specifically to discuss the leveraged ETF problem. On one hand, the central bank is tightening the capital valve for the whole market; on the other, regulators are firefighting leveraged money. Both collided on the same day. **"Quarterly Rate Hikes": Several Tightening Path Forecasts** There’s disagreement about the pace of further rate hikes, but consensus on direction—more hikes ahead. Citibank economist Jin-Wook Kim expects the BoK will keep a quarterly pace of 25 basis point hikes in H2 2026: hikes in July and October, and possibly two more in January and April 2027. According to media surveys, 28 out of 31 economists expect rates to reach 3.00% by year-end. Gareth Leather of Capital Economics says, "After Thursday’s hike, the BoK may continue to raise rates further," citing rising core inflation, property-driven financial stability risks, and strong exports supporting higher rates. HSBC economist Jin Choi is more cautious, predicting another 25 basis point hike in Q4 after this week’s increase, and risks of further hikes in 2027 are to the upside. Crédit Agricole believes the BoK won't hike in August but more likely in October—because updated macro forecasts and forward guidance arrive in August, and international oil prices have fallen. KB Financial Group analyst Lim Jae-kyun points to two rate hikes this year, with October being more likely than consecutive hikes in July and August. **Part of the Global Wave of Central Bank Tightening** Korea is not alone. On June 11, the ECB announced a 25 basis point hike. On June 16, the Bank of Japan raised rates by 25 basis points to 1.0%, a 31-year high. Central banks in New Zealand, Denmark, and Czechia also raised rates by 25 basis points. Reuters pointed out that Korea’s rate hike brings it more in line with other regional banks like Japan that recently tightened policy. An interesting contrast: Fed Chair Walsh testified to Congress this week, disputing claims that surging AI investment would drive inflation, saying "this boom may not lead to sustained price pressures." The Bank of Korea takes the opposite view—Shin Hyun-Song specifically cited the AI chip boom as a major driver of sticky inflation. The Bank of Korea’s central conundrum, as Bloomberg puts it, is striking a balance between "preventing financial imbalances" and "not stifling AI investment momentum." Hyundai Motor Securities economist Jemin Choi said, "Bank of Korea is expected to maintain a hawkish stance and keep the option for further tightening. While inflation, currency, and Middle East conflict-related risks remain, they have not materially worsened, making it more likely to maintain the current stance than turning more hawkish." Risk Warning and Disclaimer The market carries risks, and investments require caution. This article does not constitute personal investment advice, nor does it take into account particular investment objectives, financial situations, or needs of individual users. Users should consider whether any opinions, views, or conclusions in the article fit their specific circumstances. Investment based on this article is at your own risk.