Turkish central bank raises benchmark rate sharply, boosts lira

Rates raised despite criticism of central bank; key interest rates at highest level since 2004; economy expected to slow down sharply; lira jumps against dollar

Turkey’s central bank raised its benchmark rate by a hefty 625 basis points yesterday, the biggest such increase in President Recep Tayyip Erdogan’s 15-year rule, boosting the lira and possibly easing investor concern over the monetary policy direction in the country.
The bank’s Monetary Policy Committee raised the one-week repo rate to 24%, meaning it has now increased interest rates by 11.25 percentage points since late April in an attempt to put a floor under the tumbling currency.
Its decision came despite Erdogan repeating his opposition to high interest rates earlier in the day, saying high inflation was a result of the central bank’s wrong steps.
Erdogan, a self-described “enemy of interest rates,” picked his son-in-law, Berat Albayrak, as finance minister in July.
All 11 economists in a Reuters poll had forecast the bank would tighten, with the predictions ranging between 225-725 basis points as it balances concerns over the lira’s weakness with worries about a sharp economic slowdown.
Turkey’s currency crisis has been driven by concerns about political influence on monetary policy, but also more recently by the country’s diplomatic row with the US.
“It is pleasing to see common sense prevail,” said Aberdeen Standard Investments Head of Emerging Market Debt, Brett Diment, of the rate rise. “Hiking today does get Turkey on the slow road to recovering some monetary policy credibility, and that is critical.”
In August, annual consumer price inflation hit 17.9%, its highest level since late 2003, prompting the central bank to say it would adjust its monetary stance at the September meeting in the face of “significant risks” to price stability.
The central bank said in its statement that there was still an upside risk to Turkey’s inflation outlook from what it called a deterioration in pricing behaviour, despite weaker domestic demand conditions.
“Accordingly, the Committee has decided to implement a strong monetary tightening to support price stability,” it said.
The lira rallied 3% to 6.15 against the dollar, having traded at 6.4176 beforehand. It has still lost 38% of its value against the US currency this year. The main share index rose 2.1%, with the banking index up 4.8%.
Dollar-denominated bonds issued by the Turkish government rose across the curve.
The central bank said it was returning to funding via one-week repos from today, having funded the market at an overnight lending rate of 19.25% for the last month.
Key rates are now at their highest level since 2004, around a year after Erdogan first came to power.
Guillaume Tresca, senior emerging market strategist at Credit Agricole said the economy needed to slow down because it was overheating and that an interest rate rise was needed to cap lira depreciation.
“Obviously, it will have negative consequences on the economy but, I would say, it is less important if you have a hard landing than big corporate defaults due to a vicious cycle between (lira) depreciation and inflation,” he said.
The lira had weakened earlier yesterday before the central bank decision as Erdogan’s fierce criticism of the central bank and high interest raised doubts in investors’ minds about how much the bank might tighten policy.
Against expectations, the central bank did not raise rates at its last meeting in July.
Subsequently, the lira lost about 25% of its value while Turkish authorities have taken a series of steps designed to support the currency, with the central bank taking liquidity measures and the banking watchdog limiting derivative transactions.
Erdogan has cast the lira crisis as an ‘economic war’ targeting Turkey, repeatedly urging Turks to sell their dollar savings to shore up the lira.
In a decision announced earlier yesterday, he ruled that property sales and rental agreements must be made in lira, putting an end to such deals in foreign currencies.