Turkey’s central financial institution hikes rate of interest lower than anticipated to 17.5%

Turkey’s Taksim Square with the figure of Kemal Ataturk, the first President, and the Turkish flag in the background.

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Turkey’s central bank hiked interest rates by 250 basis points to 17.5% on Thursday, below analysts’ forecast of 500 basis points, as the country’s policymakers embark on a long and painful mission to fight double-digit inflation.

“Monetary tightening will be further tightened as needed in a timely and gradual manner until there is a significant improvement in the inflation outlook,” the bank said in a statement following its interest rate decision.

The Turkish lire The US dollar fell about half a percentage point against the dollar on the news, trading at 26.92 against the greenback. Earlier this week, the lira hit a new record low of 26.9 against the dollar as the market feared the forthcoming rate hike would be smaller than expected. The currency has lost 30% of its value against the dollar this year.

In June, Turkey raised interest rates for the first time in more than two years after Turkish President Recep Tayyip Erdogan appointed policymakers who vowed to use economic orthodoxy to reverse inflation.

Turkey steadily lowered its benchmark interest rate from 19% at the end of 2021 to 8.5% last March as inflation skyrocketed, breaching 80% in late 2022 and falling to just under 40% in June. In its statement on Thursday, the central bank reiterated its goal of bringing inflation down to 5% over the medium term – which many economists believe is unrealistic at this rate.

Traditional economic orthodoxy holds that interest rates must be raised to curb inflation, but Erdogan — a self-proclaimed “enemy” of interest rates who calls the tool “the mother of all evils” — has been vocal in favor of a rate-cutting strategy instead .

“Terrible Decision”

Analysts reacted negatively to the news, with many calling it a mistake.

“A terrible decision and, in my opinion, a mistake. Underdelivered yet again,” wrote Timothy Ash, emerging markets strategist at BlueBay Asset Management, in an emailed note. “It will again stick with those who say that Simsek and Erkan don’t really have the mandate to enforce real monetary tightening,” he said, naming Turkey’s finance minister and central bank governor respectively.

The bank’s emphasis on an incremental pace of tightening lends credibility to some analysts’ views that policymakers are reluctant to introduce bigger and more drastic rate hikes for fear they will hurt public sentiment and support for Erdogan.

“Guess that often means small increases, but when inflation is close to 40% and the CBRT (the central bank) itself expects it to rise in the short term, these comments will fall on deaf ears. Sorry trust the CBRT is at rock bottom and needs to be rebuilt through action not words,” Ash wrote.

“Raises of 250 basis points when the market was expecting 350-500 basis points just aren’t enough.”

A picture taken on Aug. 14, 2018 shows the logo of the Central Bank of Turkey at the entrance of its headquarters in Ankara, Turkey.

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While the move “represents the second step in the move away from ultra-loose monetary policy,” June’s 650 basis-point rate hike disappointed markets that were “hoping for shock therapy following a post-election reshuffle of Erdogan’s economic team,” he said, Bartosz Sawicki , Market Analyst at Conotoxia Fintech.

“Similarly, today’s decision falls short of most market forecasts. As a result, there are doubts as to whether a gradual tightening will be enough to restore credibility and restore price stability after years of unorthodox policies.”

Although the dollar-lira exchange rate has surged in the period since Erdogan’s re-election in May, “the central bank appears unperturbed by the lira’s recent slide,” he added, assuming the rate hike was less than expected.

Bank data showed improvement in foreign exchange reserves and balance of payments. The recent trade and investment agreements with Gulf states such as the United Arab Emirates and Saudi Arabia will also boost parts of the Turkish economy. Still, these will not ensure macroeconomic stability unless enough is done to tighten policy and save the lira, observers say.

“25-30% interest rate ceilings this year still appear to be on track, but there is now a clearer risk that the policy shift will be short-changed and the lira will face much more downward pressure,” said Liam Peach, a senior emerging market economist at London-based firm Capital Economics wrote in a note.

“If monetary tightening continues to be insufficient, the lira will likely pay the price,” he said. “We expect it to drop another 10% to 30 [to the dollar] through year-end, but risks are biased towards larger and more disorderly declines.”