Turkey cuts interest rates in surprise move despite inflation soaring to 24-year-high

The country's central bank lowered its benchmark to 13% on Thursday, after keeping it at 14% for the past seven months

The Turkish currency is among five of the world’s worst performers this year against the dollar, having lost around a quarter of its value. AFP
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Turkey’s central bank delivered a shock cut to interest rates despite inflation soaring to a 24-year high and the lira trading near a record low. The currency weakened sharply.

The Monetary Policy Committee led by bank governor Sahap Kavcioglu lowered its benchmark to 13 per cent on Thursday, after keeping it at 14 per cent for the past seven months. All 21 economists surveyed by Bloomberg expected no change. The Turkish currency plummeted about 1 per cent against the dollar before paring losses.

The MPC signalled it was not embarking on a monetary-easing cycle, saying “the updated level of policy rate is adequate under the current outlook”, a statement said.

“It is important that financial conditions remain supportive to preserve the growth momentum in industrial production and the positive trend in employment in a period of increasing uncertainties regarding global growth as well as escalating geopolitical risk,” the MPC said.

The sudden resumption of monetary stimulus less than a year before elections reflects the determination of Turkish authorities to follow through on President Recep Tayyip Erdogan’s promise in June that rate cuts would continue. The decision comes three weeks after the central bank revised this year’s inflation forecast up by almost 18 percentage points.

An increase of more than $10 billion in Turkey’s gross foreign reserves over only two weeks — after money transfers from Russia for the construction of a nuclear power plant — may have given the central bank the confidence that it can wait out the pressures, especially as policymakers expect inflation to peak soon.

Mr Kavcioglu has blamed a global rally in commodity prices, partly caused by Russia’s invasion of Ukraine in February. The central bank now expects inflation to reach a high of about 85 per cent in autumn, before ending the year at about 60 per cent, or 12 times its target.

“Apparently, the increase in the Turkish central bank’s international reserves over the last month has emboldened the bank to cut the policy rate,” Per Hammarlund, chief emerging markets strategist at SEB AB, said after the decision.

A food street vendor pushes his trolley in Istanbul. Turkey's central bank expects inflation to soon reach a high of around 85 per cent. AP

“Given the more favourable global backdrop — namely falling interest rate expectations — compared to earlier this year and inflows of capital from Russia, the cut is unlikely to cause an immediate confidence crisis in the lira. However, with inflation set to accelerate again in October or November, the lira will be in for a bumpy ride,” Mr Hammarlund said.

Mr Erdogan is intent on turbocharging growth by focusing on exports and employment as part of what he calls a “new economic model”. But risks abound as the cost-of-living crisis unfolding in Turkey poses a threat to his electoral popularity.

In place of higher rates, the central bank has rolled out macroprudential measures that helped slow loan growth momentum in July. It has also relied on backdoor interventions and the introduction of state-backed accounts that shield savers from lira weakness.

The approach has allowed inflation to gallop near an annual 80 per cent and left the lira vulnerable to a sell-off. The Turkish currency is among five of the world’s worst performers this year against the dollar, having lost around a quarter of its value.

Mr Erdogan, long a believer that cheaper borrowing costs can slow inflation instead of pushing it higher, appointed Mr Kavcioglu as governor of the central bank last year, seeking more sway over monetary policy.

An easing campaign by Turkey runs directly counter to what may prove to be the most aggressive tightening of monetary policy by central banks around the world since the 1980s.

Updated: August 18, 2022, 12:58 PM