South Korea’s economy rebounded sharply in the first quarter, driven by strong semiconductor demand, though policymakers are warning that a global energy shock is likely to weigh on activity in the months ahead a note from Capital Economics reports.

After contracting in the final quarter of last year, GDP expanded 1.7% quarter-on-quarter in Q1, the fastest pace since the pandemic, while year-on-year growth accelerated to 3.6% from 1.6% in Q4. The reading was well above expectations. Government spending was the only major component not to improve, with exports the main driver of growth, rising 10.3% year-on-year and 5.1% quarter-on-quarter. Investment also recovered, particularly in new facilities, as the technology cycle fed through into domestic demand.

The data largely predate the escalation of conflict in the Middle East and the resulting surge in global energy prices. Officials say growth could be revised once fuller data are available. As a major net energy importer heavily reliant on Gulf supplies, South Korea is exposed to price volatility.

As a result, the government has introduced aggressive conservation measures, including a five-day vehicle rotation scheme and public campaigns encouraging households to reduce electricity and water consumption.

Energy-intensive industries such as petrochemicals and plastics have already begun scaling back or halting production due to raw material shortages, while aviation has moved into emergency management mode amid higher fuel costs.

To offset the impact, Seoul has announced a KRW26 trillion ($17.6bn) supplementary budget, equivalent to around 1% of GDP. The package includes KRW10 trillion in fuel price stabilisation measures through caps and subsidies, and KRW5 trillion in consumer support via vouchers and expanded public transport rebates.

Headline inflation rose modestly to 2.2% in March from 2.0% in February. While food prices are expected to rise in coming months, administrative price controls should limit pass-through from higher global energy costs, keeping inflation broadly below 3%.

However, household demand remains weak. Consumer confidence fell sharply in March and April, while household credit growth is subdued as deleveraging continues. South Korea’s household debt ratio remains high by global standards, and ongoing balance sheet adjustment is expected to constrain spending.

Equity market gains may generate some wealth effects, but these are likely limited given the concentration of household wealth in property. Housing market trends remain uneven, with gains largely confined to parts of Seoul and weakness elsewhere.

Price controls are also expected to support corporate margins at the margin, providing modest backing for investment. Facilities investment, particularly in factories and equipment, is benefiting from resilient export-oriented manufacturing. However, construction investment remains a drag due to high inventories and weak transaction volumes.

Exports continue to provide relative strength. Despite global headwinds, demand linked to artificial intelligence is supporting semiconductor shipments, particularly in memory chips where Korean firms remain competitive. Semiconductor exports rose by around 150% in value terms in March.

Looking ahead, growth is expected to slow as energy-related pressures intensify. Nevertheless, following stronger-than-expected Q1 data, the growth forecast for 2026 has been raised from 1.6% to 2.7%.

The Bank of Korea left policy rates unchanged at its April meeting. Although markets have begun pricing in possible tightening, policymakers are expected to keep rates on hold through 2026, given external headwinds and contained inflation pressures.