HomeEuropeTurkey shocks markets with rate cut despite inflation near 80%

Turkey shocks markets with rate cut despite inflation near 80%

Turkish President Tayyip Erdogan arrives for a NATO summit in Madrid, Spain June 29, 2022.

Nacho Doce | Reuters

Turkey’s central bank shocked markets Thursday with a cut to its benchmark policy rate, despite inflation in the country sitting near 80%.

The country’s currency, the lira, slid 0.9% against the dollar, trading at more than 18.1 to the greenback following the news — near a record low.

The country’s main policy rate, which had been at 14% for the last seven months, was cut to 13% in a complete mismatch to what other central banks are doing around the world.

“Another idiotic move,” commented Timothy Ash, a senior emerging markets strategist at BlueBay Asset Management.

“Insane with inflation at 80% and still rising the CBRT cuts rates, against expectations by 100bps to just 13%,” he wrote on Twitter, referring to Turkey’s central bank by its acronym.

“Ridiculous move. Obviously they have got cash in their pockets from Russia and the Gulf and think they can cut rates + hold the Lira.”

Turkey’s government has made a show of diplomatic overtures to several oil-rich Gulf states, mending formerly strained ties to attract much-needed investment, and has remained enthusiastically open to Russian business and trade despite Western sanctions and Russia’s invasion of Ukraine.

A man sells slippers in Eminonu on May 5, 2022, in Istanbul, Turkey. The country has enjoyed rapid growth for years, but President Erdogan has for years refused to meaningfully raise rates to cool the resulting inflation. The result has been a plummeting Turkish lira and far less spending power for the average Turk.

Burak Kara | Getty Images News | Getty Images

Analysts expected no rate change, so the move lower by the central bank has taken markets by surprise. The main BIST index snapped session gains to trade lower by 0.8% after the decision, though later turned positive, up 0.2% within the following hour, according to Reuters data.

The Turkish central bank’s statement Thursday said the committee expects the “disinflation process to start” and that there are signals of a “loss of momentum in economic activity.”

Turkey’s inflation for the month of July rose by an eye-watering 79.6% year on year, its highest in 24 years, as the country grapples with soaring food and energy costs and President Recep Tayyip Erdogan’s long-running unorthodox strategy on monetary policy. This time five years ago the lira traded at 3.5 to the dollar; now it’s more than 18 to one.

‘The mother of all evil’

Surging consumer prices have hit the population of 84 million hard, and few have hopes for improvement anytime soon thanks to the Russia-Ukraine war, high energy and food prices, and a sharply weakened lira.

Turkey has enjoyed rapid growth in previous years, but Erdogan for the last few years refused to meaningfully tighten policy to cool the resulting inflation, describing interest rates as the “mother of all evil.”

The result has been a plummeting currency and far less spending power for the average Turk. The lira has lost 26% of its value against the dollar year-to-date, and plunged 80% against the dollar in the last five years.

Erdogan instructed the country’s central bank, which analysts say has no independence from him, to consistently slash borrowing rates in 2020 and 2021, even as inflation continued to rise. Central bank heads who expressed opposition were fired; by the spring of 2021, Turkey’s central bank had seen four different governors in two years.

Capital controls?

The Turkish government is currently employing a range of unconventional methods to try to prop up the lira, most of which involve spending significant foreign exchange reserves or blocking lira loans to companies deemed to be holding too much foreign currency, which many economists warn is unsustainable.

There is likely more trouble ahead for Turkey, London-based Capital Economics wrote in a note Thursday. “This latest move could be the trigger for yet another currency crisis,” wrote Jason Tuvey, the firm’s senior emerging markets economist.

“It is clear that the CBRT is taking its instructions from President Erdogan, whose unorthodox views form the basis of the government’s ‘new economic model’ of low real interest rates,” Tuvey said, adding that “Turkey’s external position remains extremely poor.”

The country, a key economic and political crossroads between east and west, home to millions of Middle Eastern and South Asian refugees and the second-largest military in NATO, is also suffering from a widening current account deficit, “large short-term external debts and perilously low foreign exchange reserves,” Tuvey wrote.

“If the CBRT is to pursue further rate cuts over the coming months, we suspect that it will turn to more restrictive capital controls.”

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