Turkey’s Central Bank Hikes Key Interest Rate

Turkey’s Central Bank Hikes Key Interest Rate

Turkey’s central bank has raised the country’s key interest rate from 8.5% to 15%, almost doubling it, as the newly re-elected President Recep Tayyip Erdogan’s new economic administration embarked on a dramatic monetary policy U-turn. The bank has stated that there will be further gradual monetary tightening until the inflation picture in the country improves. This is the country’s first rate rise since March 2021 but was below analyst expectations of a 1,150 basis point hike to 20%.

The central bank, led by the newly appointed Governor Hafize Gaye Erkan, said in a statement that the monetary tightening process was initiated to establish the disinflation course as soon as possible, anchor inflation expectations, and control the deterioration in pricing behavior. However, some analysts criticized the central bank’s move as not going far enough.

The Turkish Lira’s Woes and the Need for Policy Changes

The Turkish lira weakened to around 24.1 against the dollar, a record low, following the news, according to Reuters data. Senior analysts believe that there will be further hikes in order to bring the policy rate up to 20% or higher. However, the Turkish Finance Minister Mehmet Simsek has to be cautious, as he does not want to slow down the economy too fast and inadvertently trigger a debt crisis.

Turkey had gradually lowered its policy rate from 19% in late 2021 to 8.5% in March, which lasted until inflation ballooned, breaching 80% in late 2022 and easing to just under 40% in May. Traditional economic orthodoxy holds that rates must be raised to cool inflation, but Erdogan, who calls interest rates “the mother of all evil,” espoused a strategy of lowering rates instead. The outcome was a cost-of-living crisis for Turks as the Turkish currency, the lira, plummeted, losing about 80% of its value against the dollar in the last five years. Turkey has also found itself precariously low on foreign currency reserves as it sold billions of dollars in foreign exchange to prop up the lira.

The architect of Turkey’s return to economic orthodoxy is Simsek, who is the Erdogan-appointed finance minister. After several years of Erdogan exerting heavy control over Turkey’s central bank, the president appears willing to let the monetary policymakers have more independence. Erdogan has accepted that short-term pain is necessary to redress the economy, and that appearing to empower Simsek will play well with the markets. However, some note that ultimately, Erdogan’s level of authority over his government means that if he wants to abruptly reverse course, he can.

A number of policy changes will be necessary to bring Turkey’s economy back on track. In addition to the lira sitting at its weakest ever level against the dollar, Turkey’s current account deficit has widened more than the market expected in recent months, and official reserves have been drawn down, declining by more than $8 billion in April alone. The new monetary policymakers are dedicated to raising rates and cooling inflation, but the ultimate authority still lies with Erdogan.


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