Turkey central bank surprises with 100 bps cut despite soaring inflation

Ankara  — Turkey’s central bank surprised markets on Thursday by cutting its main interest rate by 100 basis points (bps) to 13%, saying it needed to keep driving economic growth despite inflation hitting nearly 80% and a monetary tightening trend among its peers worldwide.

The lira dropped more than 1% as the bank took its latest step down the unorthodox policy path advocated by President Recep Tayyip Erdogan that aims to provide targeted cheap credit to help boost Turkish exports.

There had been virtually no signal that another rate cut was in the works and no economist polled by Reuters had predicted one, given that inflation has soared to 24-year highs, eating deeply into Turks’ earnings and savings.

The bank had held its main rate at 14% for the past seven months after cutting it by 500 bps towards the end of 2021. That policy easing sparked a currency crisis in December that sent inflation soaring.

The rate cuts long urged by Erdogan — who holds sway over the bank after ousting several of its governors in recent years — have left real interest rates in deeply negative territory and have accelerated a cost-of-living crisis for Turkish households.

Analysts expressed dismay at the decision.

“I am speechless. It is not the obvious thing to do at all,” said Kieran Curtis, fund manager at Abrdn in London.

The central bank’s policy-setting committee said it needed to act because leading indicators pointed to a loss of economic momentum in the third quarter.

“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,” it said in a statement.

The new policy rate “is adequate under the current outlook”, it said, adding the growing gap between its policy rate and rising loan rates was reducing “the effectiveness of monetary transmission”.

The currency crisis 2021 saw the lira fall 44% against the dollar, stoking inflation via imports. The currency has lost a further 27% so far this year while inflation hit 79.60% in July, partly stoked by fallout from the war in Ukraine.

The lira on Thursday broke through 18/$ for the first time since December and was on track for its weakest ever close of 18.08/$.

Against the grain

With supply constraints, consumer demand and fallout from the war stoking inflation globally, central banks across developed and emerging markets are jacking up interest rates. China is the exception.

Turkey’s inflation rate is among the highest worldwide while its real interest rate, at minus 67%, is among the lowest.

Ozge Arslan, a teacher in Istanbul, said rising electricity and natural gas bills had forced her family to reduce their oven and kettle use and to take shorter showers.

Opinion polls show such concerns have hit the popularity of Erdogan, who faces a tough election by mid-2023. He has made little mention of interest rates since June 6, when he said Turkey would continue cutting rather than raising them.

The bank said inflation is driven by the lagged effects of rising energy prices, pricing formations not supported by economic fundamentals, and negative supply shocks.

It repeated that disinflation should begin thanks to steps the bank and other authorities have taken to cool some forms of credit, along with an eventual end to the war.

In the Reuters poll, all 14 economists had expected the benchmark one-week repo rate to remain unchanged this week. Only one economist predicted a cut later in the year.

The bank last month raised its year-end inflation expectation to 60.4%, compared with economists' median estimate of 70%. It sees inflation peaking near 90% this autumn.

Reuters