Turkey’s apex bank cautiously raises rate 17.5%

Thursday saw Turkey’s central bank taking action to address the country’s soaring double-digit inflation, as it raised its key interest rate by 250 basis points to 17.5%. Though this move fell short of analysts’ expectations of a 500 basis points increase, the bank expressed its commitment to further strengthen monetary tightening as needed until a substantial improvement in the inflation outlook is achieved.

In response to the interest rate decision, the Turkish lira depreciated by approximately half a percentage point against the US dollar, trading at 26.92 to the greenback. This decline comes after concerns in the market that the rate hike would be insufficient, adding to the lira’s woes, as it has already lost 30% of its value against the dollar this year.

In June, Turkey had increased its key interest rate for the first time in over two years, aiming to combat the surging inflation. The recent rate hike is part of the efforts to implement economic orthodoxy following the appointment of policymakers dedicated to tackling the inflationary pressures.

However, the challenge lies in Turkey’s ambitious target to reduce inflation to 5% in the medium term, a goal deemed unrealistic by many economists, considering the current rate stands at just under 40%.

Traditionally, raising interest rates has been a recognized method to cool down inflation. However, Turkish President Recep Tayyip Erdogan, who is openly against higher interest rates, has advocated for lowering rates instead, dismissing them as “the mother of all evil.”

Financial analysts have reacted negatively to the central bank’s decision, with some considering it a mistake and a missed opportunity to take more substantial measures to stabilize the economy. Market participants were expecting more aggressive rate hikes of up to 500 basis points, raising concerns about the central bank’s ability to restore credibility and price stability after years of unorthodox policies.

Despite the recent improvement in foreign exchange reserves and balance of payments, there are apprehensions that the gradual tightening pace adopted by the central bank may not be enough to rescue the struggling Turkish lira. While recent trade and investment agreements with Gulf countries may offer some support to the Turkish economy, observers argue that more decisive actions are required to ensure macroeconomic stability.

In light of the ongoing economic challenges and doubts surrounding the effectiveness of the central bank’s measures, analysts predict that the Turkish lira could face further downward pressure. Some forecasts anticipate a 10% depreciation against the US dollar, potentially falling to 30 lira to the dollar by the end of the year, with the risk of more disorderly declines if monetary tightening remains insufficient.