Turkey surprises with significant rate hike to 25% and boosts the lira

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Turkey’s central bank made a surprising move by increasing its key interest rate by 750 basis points to 25% on Thursday. This unexpected decision resulted in a rare lira rally and demonstrated a new determination to address the rebounding inflation as part of a broader policy shift.

This rate hike is the largest since 2019, and it pushed the Turkish currency to its strongest level since mid-July. The central bank has been gradually raising its one-week repo rate by 1,650 basis points since June.

The policy committee, which included three new members known for their hawkish stance, emphasized its commitment to tightening monetary policy as much as needed to combat inflation. Inflation reached nearly 48% last month.

Analysts believe that this move marks a significant shift towards more orthodox policies after years of unorthodoxy under President Tayyip Erdogan. They expect that this decision will help to control inflation expectations.

The lira has been hitting all-time lows almost daily in recent weeks, but it surged over 3% against the dollar following the rate hike announcement and was at 26.41 at 1205 GMT.

The Turkish bank stocks rose nearly 10%, which also lifted the broader Istanbul stock market. Moreover, the government’s dollar-denominated bonds increased by over 2 cents according to Tradeweb data.

Prior to the announcement, economists in a Reuters poll had expected a median rate hike of 250 basis points from the previous rate of 17.5%. Some experts were even anticipating a more moderate move considering that the central bank had fallen short of market expectations in the past two months.

According to the poll conducted the week before, economists did not anticipate interest rates to reach 25% until the end of the year.

The 750 basis points rate hike “sends a very strong signal that the central bank is determined to rein in inflation, and the initial market response is very positive,” noted Piotr Matys, senior FX analyst at In Touch Capital Markets.

However, there are concerns that some investors may question whether the rate hike has been approved by President Erdogan.

A Turnaround for Turkey

In June, Erdogan appointed former Wall Street banker Hafize Gaye Erkan to be the head of the central bank. This decision was made following his re-election in May, as the economy was grappling with depleted foreign exchange reserves and soaring inflation expectations.

In July, three new policy makers, namely Osman Cevdet Akcay, Fatih Karahan, and Hatice Karahan, were appointed to the central bank, indicating a stronger commitment to tackling inflation by independent economists. Inflation has persistently exceeded the official 5% target for years.

Erdogan’s previous push to lower interest rates resulted in a currency crisis in late 2021 and sent inflation soaring to over 85% last year. Annual consumer prices are expected to rise to around 60% by the end of this year, partially due to currency depreciation.

The central bank stated that rising oil prices and deteriorating inflation expectations suggest that inflation will reach the upper end of its forecasts by year-end. However, it anticipates that disinflation will be achieved by 2024.

The Turkish lira has depreciated by approximately 68% over the past two years, mainly due to Erdogan’s opposition to high interest rates and his influence over the central bank. The currency experienced another plunge this summer as the new economic team in Ankara implemented more conventional policies, loosening the state’s control over foreign exchange markets.

The central bank has also taken steps to tighten credit selectively. Over the weekend, it began rolling back a costly program designed to protect lira deposits against forex depreciation, which was implemented to stop the currency crash in late 2021.

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