Bank of Korea Governor Rhee Chang-yong’s hawkish stance, combined with the KOSPI’s slide into a technical bear market, is pushing South Korea’s capital markets toward a difficult crossroads. Expectations of rate hikes, persistent foreign capital outflows, and structural risks from leveraged ETFs are converging simultaneously, subjecting a market once highly sought-after for its semiconductor boom to a severe test.

Speaking at a National Assembly Strategy and Finance Committee hearing on July 9, Rhee explicitly stated that given the combination of above-target inflation, improving economic growth, and rising financial stability risks, “the base rate needs to be raised at an appropriate time.” Markets widely expect the Bank of Korea’s Monetary Policy Board meeting on July 16 to announce a rate hike — the first since August 2021. Following the news, the KOSPI index initially surged more than 4% in early trading before abruptly reversing course, with the violent swing in market sentiment reflecting deep investor division and unease.

The macro backdrop is far from favorable. The KOSPI has fallen more than 20% from its June peak, entering a technical bear market. On July 7, the market triggered both program trading halts and circuit breakers in a single session, with Samsung Electronics (005930.KS) and SK Hynix (000660.KS) leading the decline sharply. Against this backdrop, investors are searching for answers on whether the rate hike will serve as a policy signal boost or additional pressure on an already fragile market.

Hawkish Signals Intensify, Rate Path Becomes Clearer

Since taking office in May, Rhee has repeatedly and publicly emphasized the necessity of rate hikes, with his language growing more explicit each time. During a speech marking the Bank of Korea’s founding anniversary on June 12, he stated that “price stability should be the core focus, and rate hikes should proceed swiftly.” On June 17, he spoke again, pledging to proactively introduce policies to stabilize prices.

At the July 9 hearing, Rhee identified inflation as the core reason for hiking rates, specifically pointing to the sources of price pressure — not only oil price transmission driven by Middle East tensions, but also the wealth effect from massive performance bonuses at semiconductor companies and the KOSPI’s sharp rally, both of which are fueling consumer demand. He warned that “the inflation rate is expected to remain elevated for a considerable period.”

In its business report submitted to the National Assembly, the Bank of Korea also stated that “considering changes in policy conditions, including above-target inflation, improving growth momentum, and rising financial stability risks, it is necessary to raise the base rate at an appropriate time.” This represents formal institutional endorsement of the governor’s stance.

Inflation Breaches 3% Again, Demand-Side Pressures Take Over from Supply

The data makes the urgency of rate hikes clear. South Korea’s June consumer price index rose 3.2% year-on-year, far exceeding the central bank’s 2% target, while the cost-of-living index, which reflects daily expenses, surged even higher at 3.4%. Price increases were around 2% in January and February this year, breached 3% from May as Middle East tensions escalated, and have remained elevated since.

Rhee noted that first-half inflation was primarily driven by international oil price transmission, representing a supply-side shock. However, he specifically emphasized that inflation drivers are undergoing a structural shift — massive performance bonuses distributed by major semiconductor firms like Samsung Electronics and SK Hynix, along with household asset expansion driven by the KOSPI’s surge, are both amplifying demand-side consumption pressures. This shift means that even if energy prices retreat, price pressures will prove more persistent.

The Bank of Korea expects that downward pressure from declining international oil prices will be offset by expanding demand-side inflation, keeping consumer prices elevated.

Citigroup Expects Two Hikes This Year, Tightening Cycle Just Beginning

Markets have largely reached consensus on the outcome of the July 16 meeting. Citigroup economist Jin-Wook Kim expects the Bank of Korea to raise the base rate by 25 basis points from 2.50% to 2.75% at next week’s meeting, signaling a gradual pace of tightening.

Citigroup’s base-case forecast is for rate hikes in July and October this year, followed by additional hikes in January and April next year. Jin-Wook Kim said he expects Rhee to signal 25-basis-point quarterly hikes through the second half of 2026, while maintaining a data-dependent stance for the first half of 2027 without providing specific forward guidance.

Citigroup also expects the central bank may emphasize upside risks to its 2026 growth forecast, citing upward revisions to first-quarter GDP and resilient second-quarter economic activity. This path implies that the coming rate hike is not an isolated event, but the start of a multi-step tightening cycle. For an already pressured stock market, the rate normalization process will constitute sustained valuation pressure.

Triple Risks Converge, Stock Market Mired in Bear Market

Even before rate hike expectations materialized, South Korea’s stock market had already undergone a sharp correction. The KOSPI has fallen more than 20% from its June peak into a technical bear market, triggering both sidecar and circuit breaker mechanisms in a single session on July 7, closing at 7,246.79.

Foreign capital flight is the primary pressure point. Foreign investors net sold 148 trillion won (approximately $103.6 billion) in KOSPI stocks in the first half, with daily net selling exceeding 1.3 trillion won (approximately $910 million) in the most recent two trading sessions, concentrated in Samsung Electronics and SK Hynix. The logic behind the exodus is clear: the KOSPI rallied approximately 60% from April to June, while the won depreciated from 1,200 to 1,566 against the dollar over the same period, hitting a 16-year low — dollar-denominated asset holders facing foreign exchange losses upon settlement made profit-taking pressure entirely rational.

Leveraged ETFs constitute the second risk. Fourteen single-stock 2x leveraged ETFs tracking Samsung Electronics and SK Hynix were listed in late May. On July 7, they plunged 12% to 13% across the board, with 13 of the 14 products falling below their 20,000 won (approximately $14) issue price. Combined trading volume for 16 single-stock leveraged and inverse ETFs reached 13.1 trillion won (approximately $9.2 billion) that day, accounting for more than one-third of total market ETF turnover. Since Samsung Electronics and SK Hynix together represent over half of KOSPI’s market capitalization, the hedging sell orders triggered by daily rebalancing of leveraged ETFs create additional selling pressure on the underlying stocks, amplifying broader market declines.

Concentration risk is a structural vulnerability that the Bank of Korea itself has flagged. In written responses submitted to the National Assembly, the central bank warned that single-stock leveraged ETFs could lead to excessive capital concentration in a handful of stocks and exacerbate market volatility through daily rebalancing.

The “Semiconductor Paradox” Persists, Policy Space Limited

What confounds the market is the deep disconnect between fundamentals and share prices. Samsung Electronics posted second-quarter operating profit of 89.4 trillion won (approximately $62.6 billion), with semiconductor demand structurally strengthening amid expanding global AI infrastructure investment. Yet the best earnings in history have coincided with the most brutal sell-off.

The Bank of Korea has assessed this, noting that the semiconductor market appears to be showing a stronger upward trend than in past cycles, while also pointing out that uncertainty over AI profitability prospects, actual investment contraction among major tech companies, and energy bottlenecks all represent potential risks.

The limitations of policy tools are equally apparent. Rate hikes help curb inflation and support the won, but for a market already in a technical bear market, rising rates will directly compress valuations. The stock market stabilization fund established by the South Korean government is approximately 10 trillion won (approximately $7 billion) in size — dwarfed by the 148 trillion won in foreign net selling during the first half.

South Korea’s Deputy Prime Minister and Minister of Economy and Finance, Koo Yoon-chul, stated that the government fully understands concerns about leveraged ETFs amplifying market volatility and that relevant authorities are discussing how to minimize volatility, though no specific measures have been announced. Officials from South Korea’s Financial Supervisory Service also indicated that regulators are evaluating alternatives such as tightening product trading requirements, but noted that “any regulatory adjustments require comprehensive consideration of the impact on broader markets.”

The rate hike decision on July 16 is itself a near certainty. The real variables lie elsewhere: once the tightening cycle begins, whether the won can stabilize, whether foreign capital outflows can be stemmed, and whether leveraged products can achieve a soft landing — the answers to these three questions will largely determine whether South Korea’s stock market can find its footing amid the bear market.