Turkey slows pace of interest rate increase in surprise move

The Monetary Policy Committee raises the benchmark to 17.5% from 15%

A street market in Eminonu commercial district in Istanbul. Turkey’s central bank raised its key interest rate on Thursday to 17.5 per cent in a further sign of commitment to orthodox economic policy Show more

Turkey’s central bank slowed its pace of interest rate increases but pledged to amplify their impact on credit markets with alternative measures.

In a surprise move on Thursday, the Monetary Policy Committee, led by Governor Hafize Gaye Erkan, raised the benchmark to 17.5 per cent from 15 per cent.

Only four economists in a Bloomberg survey correctly predicted the decision, with most analysts expecting a bigger move.

Accompanying the downshift was a decision by the MPC on what it called “quantitative tightening and selective credit tightening to support the monetary policy stance”.

The MPC also said in a statement that it would continue with a gradual “simplification” of existing regulatory measures.

The central bank promised additional steps to remove excess liras from financial markets, days after an abundance of local currency at domestic lenders forced the monetary authority to step in and mop up some of the liquidity for the first time since late 2019.

“Monetary tightening will be further strengthened as much as needed in a timely and gradual manner until a significant improvement in the inflation outlook is achieved,” the committee said.

The decision dials back the pace of rate increases that started after Ms Erkan’s appointment last month, as part of a tightening cycle that will also feature alternative tools.

The restraint in moving away from the easy-money policy favoured by President Recep Tayyip Erdogan further exposes local assets to a sell-off as inflation still hovers near 40 per cent.

“A rate hike by the central bank that was below even the lowest expectations is a negative development for the lira,” said Haluk Burumcekci, an Istanbul-based economist.

Policymakers could opt to raise reserve requirements for commercial lenders to reduce lira liquidity in the system, he said.

Turkish stocks extended their rally while the lira maintained losses after the announcement, trading about 0.3 per cent weaker against the dollar as of 3.36pm in Istanbul.

“The size of the central bank’s rate hike is a surprise given the financial system’s recent surge in lira liquidity,” said Bloomberg Economics.

“In our view, this may prompt the central bank to tighten its reserve requirements – reminiscent of a move previously employed by the central bank. That, if it happens, would cast further doubt over the rates outlook.”

In unwinding years of unconventional measures, Mr Erdogan’s new economic team is scaling back support for the lira, rebuilding foreign reserves and simplifying regulations that were used to stabilise the Turkish currency.

In June, the central bank delivered its first rate increase in more than two years, opting for a 650 basis-point step that underwhelmed the market.

The Turkish President has also looked for financial help abroad, visiting the Gulf region this week and securing provisional deals with the UAE that could be worth more than $50 billion.

Foreign direct investments and higher tourism income will help Turkey narrow the deficit in its current account and rein in inflation, the central bank said in its statement.

At the same time, authorities are moving ahead with fiscal measures that Barclays said are “stronger than we previously expected”.

The new steps – which range from increases in several value-added tax rates to higher corporate levies for banks – became necessary in part to pay for costly promises made to voters by Mr Erdogan before May elections.

“The authorities might be planning to compensate for less than ideal tightening on the monetary policy side by tighter fiscal policy,” Barclays economist Ercan Erguzel said in a research note before the rate announcement.

The balancing act will grow even more tricky with the approach of local elections next March. Faster economic growth could again become a priority as Mr Erdogan focuses on trying to wrest some of the country’s biggest cities from the opposition.

In the backdrop, the lira is trading near record lows in a further threat to inflation. The Turkish currency has lost more than 30 per cent of its value this year, the biggest depreciation in emerging markets after Argentina’s peso.

Under Ms Erkan’s predecessor, the central bank was projecting that price gains would end the year at 22.3 per cent, an outlook likely to be revised higher next week when the central bank unveils its new quarterly inflation report.

The presentation will effectively mark Ms Erkan’s public debut since the new governor has so far made only sparse remarks about the direction of monetary policy.