Turkey lowered interest rates by 150 points despite 83% inflation

Turkish President Recep Tayyip Erdogan attends a press conference after his meeting with the Venezuelan President in Ankara on June 8, 2022.

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Turkey’s central bank on Thursday cut its key interest rate by 150 basis points, from 12% to 10.5%, for the third month in a row, despite Turkey’s inflation exceeding 83%.

Market analysts had expected a 100 basis point cut, so despite the increasing regularity of Turkey’s rate cuts, the move still surprised many. Consumer prices in the country of 84 million people rose 83.45% in September to their highest level in 24 years, although many people living in Turkey say the prices of basic goods have in some cases more than tripled in the past year.

The country’s monetary policy directed by Turkish President Recep Tayyip Erdogan is aimed at growth and export competition, not inflation mitigation. Erdogan openly defends the unorthodox belief that interest rate hikes increase inflation, not the opposite, and has called interest rate hikes “the mother of all evils.”

The policy has consistently drawn criticism and bewilderment from economists, and has played a major role in the sharp weakening of the lira, Turkey’s currency, which has lost nearly 28% against the dollar this year.

The lira was roughly flat after hitting an all-time low on the news at 18,615 to the dollar. It has fallen by 50% against the dollar in the last year. Turkey’s current account deficit narrowed in August, helped by tourism receipts, but still stood at a significant $3.1 billion, according to Goldman Sachs.

Daniel Wood, portfolio manager at William Blair, said: “The lira remains weak, real incomes are artificially low, inflation has risen and the current account remains in deficit. This has caused international investors to leave Turkey’s local currency bond market in recent years.” Investment Management wrote in a note on Thursday.

People look at a gold shop at Istanbul Grand Bazaar on October 06, 2022 in Istanbul, Turkey.

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The Turkish government has pursued alternative strategies to strengthen its currency, including encouraging lira deposits in banks, selling dollars for lira that reduce foreign exchange reserves, and seeking investment and aid from wealthy Gulf states to finance currency intervention.

Ankara has also maintained friendly relations with Moscow and attracted Russian millionaires and billionaires trying to evade Western sanctions.

Election strategy?

It’s all about winning the next Turkish general election in July 2023, says Timothy Ash, senior emerging markets strategist at BlueBay Asset Management.

“These pro-growth policies may win Erdogan the election, but they will increase import demand, weaken competitiveness, and certainly increase the current account deficit massively,” he said in an emailed note to clients.

However, Erdogan is determined to reduce the country’s interest rate to single digits by the end of this year.

“My biggest fight is against the interest rate. My biggest enemy is the interest rate. We lowered the interest rate to 12%,” the president said at an event held at the end of September. “Is it enough? It’s not enough. It has to go lower.”

A woman poses with the Turkish lira currency in Istanbul on August 13, 2018. The lira hit another record high overnight, prompting Turkey’s Central Bank to act to stem the lira’s slide, but the move was not enough to quell investors’ fears about the currency. financial crisis in countries.

Chris McGrath | Getty Images

Turkey’s central bank has hinted at another interest rate cut in November, but it could be the last cut, saying financial conditions should remain “supportive” of growth amid a weakening demand environment. He added that slowing foreign demand and pressures on the manufacturing industry are being “closely monitored” and that “credit, collateral and liquidity policy options will continue to be implemented.”

“The committee assessed taking a similar step at the next meeting and ending the period of reduction of the discount rate,” the bank said.

“This guidance acknowledges that cutting interest rates when inflation is so high is hardly the right thing to do,” Liam Peach, chief emerging markets economist at London-based Capital Economics, said in an emailed note. “But at the same time, it will increase interest rates to 9% and satisfy President Erdogan’s desire to reduce interest rates to single digits.”

In the meantime, he said, “policymakers will continue to search for a ‘new economic model’ that focuses on ‘lira’ as one of the main channels for sustained inflation reduction.”

But “one major threat remains the lira,” Peach said, adding that the currency has managed to remain stable at around 18.6 to the dollar. “In light of Turkey’s high inflation rate, current account surplus (5% of GDP in August) and tightening of external financing conditions, risks are increasingly pointing to currency depreciation.”

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