Turkey’s central bank on Thursday delivered a much larger-than-expected interest rate increase, in a bid to further restore its credibility on monetary policy.
The central bank announced it was lifting its one-week repo auction rate, known as the policy rate, to 19% from 17%. While a rate rise was largely expected, most economists had penciled in an increase of 100 basis points to 18%. The Turkish lira strengthened, trading at 7.703 to the U.S. dollar
versus 7.51 late Tuesday.
Analysts described the Central Bank of Turkey’s move as a sign that policy makers led by Gov. Naci Agbal have room to act in response to rising inflation. Agbal began delivering rate hikes following his appointment last fall. Previously Turkey’s president, Recep Tayyip Erdogan had pressured policy makers to keep rates low, espousing a puzzling theory that high rates led to high inflation.
Erdogan has recently refrained from criticizing high interest rates and vowed to support efforts to achieve single-digit inflation, said Maya Senussi, senior economist at Oxford Economics, in a note.
Inflation has continued to push to the upside, hitting 15.6% in February. Recent weakness in the lira was one of the factors, which itself was fueled by fears that more orthodox policy-making by the central bank could be set to unravel, said Jason Tuvey, senior emerging markets economist at Capital Economics, in a note.
There’s still much work to be done, Tuvey said.
“Bringing inflation under control will require the CBRT to break with the past and move slowly with monetary easing to keep real interest rates high for a prolonged period,” he wrote. “There are strong signals that it intends to do so — the statement repeated the CBRT’s assertion that the policy stance will remain tight ‘until permanent price stability and the 5% target are reached.’”
Meanwhile, Turkey’s “dire” external financing position leaves it vulnerable to hits to global risk appetite, he said, and there’s the risk that as a tighter monetary stance dampens economic growth, Erdogan could put pressure on the bank to loosen policy. That said, it appears the shift in policy-making is a political calculation and a response from within the ruling AK Party over concerns about economic management, Tuvey wrote.
Emre Peker, director for Europe at Eurasia Group, said Erdogan’s patience may be “wearing thin.”
The president’s advisers and pro-government media have been attacking Agbal’s policies, and their criticism may intensify following the latest hike, he wrote.
“This will not diminish Agbal’s access to the president or trigger his early dismissal five months into the job. Yet, it will precipitate Erdogan increasingly heeding advisers who advocate a premature easing cycle, narrowing Agbal’s room to operate,” Peker said.
Tuvey said he expected the CBRT to keep the rate at 19% through the rest of the year, before lowering it to 16.5% by the end of 2022, while the consensus forecast, which will likely shift higher following Thursday’s hike, is for rates to end next year at 13.5%.
“If we’re right, inflation should return to single digits on a sustained basis. By lowering inflation expectations and reducing risk premia, this would be a more supportive environment for the lira,” he said.