Turkey cuts interest rates again despite 80% inflation

Turkey cuts interest rates again despite 80% inflation

Russian tourists to Europe dropped sharply over the summer, but increased to several other destinations, including Turkey (here).

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Turkey’s central bank surprised markets yet again with its decision on Thursday to cut its key interest rate, despite inflation in the country topping 80%.

The country’s policymakers opted for a 100 basis point cut, raising the key one-week repo rate to 12% from 13%. In August, the Turkish inflation rate was recorded at 80.2%, accelerating for the 15th consecutive month and the highest level in 24 years.

Turkey also cut interest rates by 100 basis points in August and had gradually lowered interest rates by 500 basis points by the end of 2021, triggering a currency crisis.

A statement from the central bank said it has “assessed the updated level of policy as appropriate under the current outlook,” according to Reuters. He said the cut was necessary as growth and demand continued to slow, also citing “increasing geopolitical risk.”

He said markets should expect “the disinflation process to start” in the wake of the measures taken, Reuters reported.

The direction of the policy has long surprised investors and economists, who say the refusal to tighten policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long criticized interest rates. and has turned against economic orthodoxy by insisting that lowering rates is the way to go. to lower inflation.

The months-long campaign to continually lower rates as Turkey’s trade and current account deficits skyrocket and its foreign reserves dry up has instead sent Turkey’s currency, the lira, into a tailspin. of several years.

The lira has lost more than 27% of its value against the dollar so far this year, and 80% in the last five years. Following the announcement of the bank’s rate decision, the currency fell a quarter of a percentage point, trading at an all-time low of 18.379 per dollar.

More danger ahead for the lira

Many economists predict a further fall in the lira. London-based Capital Economics expects it to fall to 24 against the dollar in March 2023.

“Room for further easing is becoming increasingly limited given the pressure this is putting on the lira and real rates,” Liam Peach, senior emerging markets economist at the firm, told CNBC. “Turkey has such a large current account deficit and has become dependent on foreign capital inflows to finance it. Turkey’s foreign exchange reserves are so low that the central bank is really in no position to intervene,” he said.

At some point, confidence will be so low that those vital inflows are likely to dry up, Peach warned: “Cutting interest rates further makes it more difficult for Turkey to attract those capital flows.”

Meanwhile, Erdogan remains optimistic, forecasting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview Tuesday. Erdogan is not an economist by training.

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