Turkey’s central bank raised interest rates to 15% on Thursday, the first increase since 2021 and part of a policy adjustment by the nation’s new economic leaders.
The bank increased the country’s benchmark interest rate, the one-week repo rate, to 15% from the previous low of 8.5% under the previous governor.
Although the decision represents a new policy, it is likely to disappoint investors and economists who urged the bank to raise interest rates above the current inflation rate of 39%.
The lira and government bonds declined in value following the bank’s announcement, which fell far short of the forecasts of major banks and analysts, some of whom had predicted that Turkey would double, triple, or even quadruple interest rates on Thursday.
“This dovish decision raises doubts about the duration of the hiking cycle and fails to rein in inflation expectations,” said Selva Demiralp, a former Federal Reserve Board economist and current professor at Istanbul’s Koc University. “The pressures on the Turkish lira will continue.”
President Recep Tayyip Erdogan replaced his finance minister and the director of the central bank after surviving a contentious re-election campaign in May, during which a cost-of-living crisis eroded support for his party.
Prior to Thursday’s decision, Erdogan exerted pressure on the bank to reduce interest rates despite the country’s high inflation rate, the antithesis of what central banks around the world typically do.
Contrary to what economists have observed throughout history, the Turkish president asserts that the policy will promote economic development and that lower interest rates will eventually reduce inflation.
Erdogan has attempted to mitigate the economic imbalances caused by his credit-fueled growth drive with a complex web of regulations and financial programs. It has also critically diminished the country’s foreign currency reserves and eroded the living standards of millions of Turkish citizens.
This is the first decision made by the nation’s new central bank governor, Hafize Gaye Erkan. Erdogan appointed the country’s first female central bank governor in early June. She is a Princeton-trained expert in financial risk management and a former executive at First Republic Bank and Goldman Sachs Group.
Erdogan also reinstated Finance Minister Mehmet Simsek, one of his longstanding lieutenants who returned to the government in June after a five-year absence, in an effort to reassure investors who have pulled their money out of Turkey in recent years.
Weeks of anticipation and market uncertainty preceded Thursday’s decision, as both Erkan and Simsek provided few policy specifics after their appointments, including no specific statements about interest rates. The ambiguity prompted some Western institutions and analysts to anticipate a more aggressive step on Thursday to control inflation.
“It raises concerns among market participants. The decision is insufficient to contain inflation, according to Turkish economist Ugur Gurses.
Some investors and analysts view Simsek and Erkan’s decision as a gradual return to conventional economic policy, in which they may continue to raise interest rates throughout the year.
The central bank signaled that additional rate hikes were forthcoming. “Additional monetary tightening will be implemented as necessary and in a timely manner until a significant improvement in the inflation outlook is achieved,” it stated.
In recent years, the Turkish lira has lost 90% of its value, putting the country’s finances in jeopardy. In response, Erdogan has slashed interest rates and spent tens of billions of dollars to shore up the Turkish lira, which has lost 90% of its value.
This strategy has resulted in rampant inflation, which has increased the cost of food, housing, medication, and other necessities and strained the nation’s finances. The nation is experiencing a severe shortage of foreign currency.
The majority of Turkey’s reserves are obtained through borrowing. Through currency-swap agreements, domestic institutions and foreign governments exchange dollars and other currencies for lira for a specified time period. If these transactions are excluded, Turkey’s reserves are negative $60 billion.
Before Erkan’s appointment in June, the central bank reduced its defense of the lira, which investors viewed as a sign that the government was transitioning toward a more sustainable policy. Since then, the lira has traded sideways, fueling rumors that the central bank has resumed efforts to support the currency.
“There is disappointment everywhere. Currently, they have all capital. Now is when they have all of the necessary capital. If they can’t do it during the apex of the honeymoon period, it will be extremely difficult for them to deliver what the market expects of them in the future, according to Francesc Balcells, head of global emerging markets debt at FIM Partners.
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