Turkey’s Central Bank Implements 15% Interest Rate Hike in a Startling Change to Address 40% Inflation

Turkey’s central bank has announced a significant increase in the country’s key interest rate, raising it from 8.5% to 15%. This decision comes as part of the new economic administration led by recently re-elected President Recep Tayyip Erdogan, marking a dramatic shift in monetary policy. The central bank intends to continue gradually tightening monetary policy until the country’s inflation situation improves.

This 650-basis-point rate hike is the first in Turkey since March 2021. However, it fell short of market expectations, as analysts predicted a 1,150-basis-point increase to 20%. In a statement, the central bank, under the leadership of newly-appointed Governor Hafize Gaye Erkan, explained that the tightening process aims to establish a course of disinflation, anchor inflation expectations, and control pricing behavior.

Despite the rate hike, some analysts were critical, believing it was insufficient. Timothy Ash, an emerging markets strategist at BlueBay Asset Management, expressed disappointment, stating that greater rate hikes were necessary and that the market would react unfavorably.

Following the announcement, the Turkish lira weakened to a record low of around 24.1 against the dollar, compared to its pre-decision value of 23.54, according to Reuters data.

In recent times, Turkey steadily decreased its policy rate from 19% in late 2021 to 8.5% in March. This approach was taken despite soaring inflation, which exceeded 80% in late 2022 but subsequently eased to just under 40% in May. Conventional economic thinking suggests that raising rates is necessary to combat inflation. However, President Erdogan, who openly opposes interest rates and refers to them as “the mother of all evil,” opted for a strategy of lowering rates instead.

As a result, Turkish citizens suffered from a high cost of living, and the country’s currency, the lira, experienced a significant decline. Over the past five years, the lira has lost approximately 80% of its value against the dollar. Turkey also faced challenges in maintaining sufficient foreign currency reserves as it sold foreign exchange to support the lira.

Mehmet Simsek, the finance minister appointed by President Erdogan, is credited with orchestrating Turkey’s return to conventional economic policies. Simsek, who previously served as deputy prime minister and finance minister, earned the respect of investors. After years of Erdogan exerting tight control over the central bank, the president appears willing to grant greater independence to monetary policymakers, at least for now.

Control Risks’ senior analyst, George Dyson, suggests that Erdogan recognizes the need for short-term sacrifice to restore the economy and that supporting Simsek’s actions will appease the markets. However, doubts remain about how long Erdogan can tolerate the resulting economic pain and whether he will ultimately intervene and reclaim control from Simsek.

In mid-June, Erdogan reiterated his opposition to raising rates but confirmed that he would defer to Simsek’s decisions to address inflation. He emphasized that the Treasury and Finance Minister would swiftly and comfortably take steps in collaboration with the central bank.