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Turkey’s central bank has taken a significant step in breaking away from years of unconventional policies, as its new economics team strives to tackle rampant inflation. The bank’s monetary policy committee raised the one-week repo rate by 7.5 percentage points to 25%, surpassing economists’ forecast of 20% in a FactSet poll. This is the third rate hike in as many months since President Recep Tayyip Erdoğan’s re-election in May. Central bank governor Hafize Gaye Erkan has nearly tripled interest rates since assuming office in June, in an attempt to cool down inflation. This unexpected raise in interest rates reassured investors that Turkey is returning to policy orthodoxy and could potentially alter the country’s macroeconomic outlook, according to Liam Peach, an economist at Capital Economics in London.
This decision was made after President Erdoğan appointed three new deputy central bank governors, who were well-received by investors due to their strong professional and academic backgrounds in finance. This notable tightening of interest rates marks a departure from Erdoğan’s insistence on keeping rates low, which analysts believe contributed to an overheating economy and the devaluation of the lira. Although the lira experienced a 2% increase against the US dollar following the rate hike, it still remains at historically low levels.
The central bank also cautioned that the weakening lira, recent tax hikes, and minimum wage increases would contribute to a faster pace of inflation. Inflation was predicted to reach nearly 60% by the end of the year, up from 48% in July. JPMorgan Turkey economist Fatih Akcelik believes that the central bank will raise rates by an additional 2.5 percentage points at each of its upcoming meetings, bringing the one-week repo rate to 35% by year-end.
The rate increase coincided with the government and central bank’s decision to unwind a $125 billion scheme that compensates savers when the lira depreciates against foreign currencies. Economists view this decision as a means to stabilize Turkey’s public finances and as a “back door” tightening of economic policy.
Economists have differing opinions on the extent to which policymakers can undo Erdoğan’s unconventional economic policies, especially with local elections approaching next month. Liam Peach suggests that it is uncertain whether President Erdoğan supports the rate hike, and there is a possibility that Governor Erkan may be dismissed as a result, similar to former central bank chief Naci Ağbal’s dismissal earlier this year. However, there are indications that the new policies are yielding positive results. The central bank’s gross foreign currency reserves, which reached unusually low levels prior to the general election, have increased from $48 billion to $69 billion since May. Furthermore, central bank data shows that foreign investors have made a net investment of $1.7 billion in Turkish stocks since June.
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