South Korea economy unexpectedly contracts in Q4, but AI boom brightens outlook

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Q4 GDP -0.3% q/q, versus +0.1% forecast

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Contraction due to unfavourable base effects, weak investments

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Economic growth seen stronger in 2026 on AI boom

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Central bank signals end to easing cycle

(Adds market moves, comments from central bank official, economists, policy and economic context)

By Jihoon Lee and Cynthia Kim

SEOUL, Jan 22 (Reuters) - South Korea's economy unexpectedly shrank in the final quarter of 2025, marking the biggest slump in three years on weaker investment and exports, but the global AI boom is ?set to improve the outlook and allow the central bank to retain its steady rates stance.

The contraction followed a sharp expansion in the third quarter when the new administration of ?President Lee Jae Myung rolled out stimulus policies to boost domestic demand.

"The fourth-quarter contraction has not derailed overall growth, and the policy ?backdrop points toward a cautious central bank," said Dave Chia, an economist at Moody's Analytics, echoing a ?consensus view for stronger growth ?this year underpinned by its roaring semiconductor sector.

Gross domestic product decreased 0.3% in the October-December period from the preceding three months on a seasonally adjusted basis, advance central bank ?estimates showed on Thursday, compared with a median 0.1% increase tipped in ?a Reuters poll of economists.

It was the steepest economic contraction since the fourth quarter of 2022, but analysts say the result was largely payback from the previous quarter's growth of 1.3%, which was the fastest in almost four ?years.

"On top of the unfavourable base effect, the pace of recovery ?in construction investment ?was weaker than expected, dragging down the growth rate a little more," said Lee Dong-won, director general of the economic statistics department at the Bank of Korea.

Still, domestic investment is seen improving this year as more government infrastructure projects are ?expected and companies plan to expand semiconductor factories and artificial intelligence investments, Lee said.

TECH DEMAND TO KEEP ECONOMY HUMMING

South Korea's stock benchmark topped 5,000 points for the first time in morning trade on Thursday, powered by gains in chipmakers like Samsung Electronics and SK Hynix, a level targeted by President Lee in just over six months since he took office.

Construction investment, down 3.9%, was the biggest drag in the last quarter, while facility investment dropped 1.8%. Private consumption rose 0.3%, after expanding 1.3% in the previous quarter on a boost from the ?government's extra ?budget.

Exports fell 2.1%, hurt by autos and machinery despite a tariff deal with the U.S. that was finalised in November, while imports declined 1.7%, resulting in a net negative contribution of 0.2 percentage points.

Asia's fourth-largest economy grew 1.0% in ?2025, after expanding 2.0% in 2024, marking the slowest annual growth since 2020, according to the BOK, which expects the economy to grow 1.8% in 2026.

The government expects stronger growth of 2.0% this year.

The Bank of Korea last week signalled an end to its current easing cycle after keeping interest rates unchanged, prioritising foreign exchange stability as it flagged upside risks to this year's economic growth.

"With pressure from a weaker won in focus, rate cuts in early 2026 appear unlikely; easing now could worsen currency depreciation, heighten financial stability risks, and revive inflation pressures," said Chia of Moody's Analytics.

On a year-on-year basis, ?GDP expanded 1.5% in the fourth quarter, after rising 1.8% in the third quarter, also missing economists' expectations for a median 1.9% increase.

"Growth held up last year on strong semiconductor exports and it is clear that this year will be stronger than last year, but other than the semiconductor sector, there is little momentum on the ?domestic demand side," said Park Sang-hyun, an economist at iM Securities. (Reporting by Jihoon Lee and Cynthia Kim; Editing by Jamie Freed and Shri Navaratnam)