Turkey's central bank headquarters in Ankara, Turkey. Picture: REUTERS/UMIT BEKTAS
Turkey's central bank headquarters in Ankara, Turkey. Picture: REUTERS/UMIT BEKTAS

 Istanbul — Turkey’s new central bank governor, Naci Agbal,  raised the benchmark interest rate aggressively at his first meeting in  a move that strengthened the lira.

The monetary policy committee increased the one-week repo rate to 15% from 10.25% on Thursday — the most in two years — as forecast by most analysts polled by Bloomberg. The central bank said all funding will be provided through the main policy rate.

The lira rallied as much as 2.5% against the dollar after the decision. It then pared gains and was trading 1% stronger at 2.23pm in Istanbul.

“The committee has decided to implement a transparent and strong monetary tightening to eliminate risks to the inflation outlook, contain inflation expectations and restore the disinflation process,” the central bank said in a statement.

The decision suggests that unlike his recent predecessors, Agbal — who was appointed in November as part of a sweeping overhaul of Turkey’s economic decisionmakers — has the backing of President Recep Tayyip Erdogan for a more orthodox effort to protect the lira and curb inflation.

After long advocating the theory that high interest rates cause rather than curb inflation, the president pledged to support his new economic managers with market-friendly policies after declines in the currency to record lows.

Restoring credibility

“Agbal made the first important step to restore the shattered credibility of Turkey’s central bank by delivering a proper rate hike and simplifying monetary policy,” said Piotr Matys, a London-based strategist at Rabobank. “The initial market reaction implies that this should be enough for the lira to maintain its bullish momentum.”

Agbal inherited a complicated funding structure from his predecessor Murat Uysal, who relied on backdoor tightening using fringe tools.

Uysal’s approach lifted the average cost of funding to 14.8% on Wednesday, from less than half that level in July. But even supported by state lenders’ unannounced interventions in foreign-exchange markets using central bank reserves, it failed to stem the lira’s collapse.

With inflation in double digits for much of 2020, the real interest rate was negative. The currency performed worst among emerging markets peers in 2020 up until Agbal’s appointment on November 7 and the resignation soon after of the president’s son-in-law as economy minister.

Shortly before he was sworn in with sweeping authority in 2018, Erdogan promised to seize control of monetary policy to implement his unorthodox views on interest rates and prices. Turkish markets were routinely hammered over the after two years.

Last week, with the lira way above 8 to the dollar, he changed tack, sparking optimism Turkey will allow interest rates to rise to offer a sufficient inflation-adjusted return.

The statement said the monetary authority will only use its one-week repo rate to fund commercial banks, a step towards making policy more predictable. Economists have been suggesting that the central bank should drop the less transparent approach brought back in August.

“The repo rate is now in line with market rates, so the net tightening is minimal,” said Nigel Rendell, a senior analyst at Medley Global Advisors. “At least the market is relieved over the fact that the central bank is returning to a conventional monetary policy.”


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