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Turkey’s central bank delivered a shock cut to interest rates despite inflation soaring to a 24-year high and the lira trading near a record low. The currency weakened sharply.
The Monetary Policy Committee led by Governor Sahap Kavcioglu lowered its benchmark to 13% on Thursday, after keeping it at 14% since December. All 21 economists surveyed by Bloomberg expected no change. The Turkish currency declined about 1% against the dollar before paring losses.
The MPC signaled it’s only responding to a possible slowdown in manufacturing and not embarking on a monetary-easing cycle, saying “the updated level of policy rate is adequate under the current outlook,” according to a statement.
“It is important that financial conditions remain supportive to preserve the growth momentum in industrial production and the positive trend in employment in a period of increasing uncertainties regarding global growth as well as escalating geopolitical risk,” the MPC said.
The sudden resumption of monetary stimulus with less than a year before elections reflects the determination of Turkish authorities to follow through on President Recep Tayyip Erdogan’s promise in June that rate cuts will continue. The decision follows three weeks after the central bank revised this year’s inflation forecast higher by almost 18 percentage points.
Juiced up by ultra-loose monetary policy, the $800 billion economy blazed ahead at a record pace when it emerged from the pandemic and has continued to expand at one of the fastest rates in the Group of 20. But the central bank is now warning of “some loss of momentum in economic activity” at the start of the third quarter.
What Bloomberg Economics Says...
“We see no economic motivation behind the decision and instead consider macroeconomic conditions as warranting a strong hike. The central bank, however, has opted for the preference of the political leadership to lower borrowing rates as it focuses on growth.”
--Selva Bahar Baziki, economist. Click here for more.
Last month, business conditions among Turkish manufacturers deteriorated the most since May 2020 after output and new orders suffered their worst performance since the first wave of the coronavirus pandemic. The threat of a recession in Europe, the main destination for Turkish shipments abroad, is a big worry for an industry that now accounts for 95% of Turkey’s total exports.
“The central bank’s decision today stresses the need to support the domestic economy while allowing macroprudential measures and external factors to reduce inflation pressures,” said Simon Harvey, head of FX analysis at Monex Europe Ltd. “Loosening the main policy rate to support growth suggests that bringing inflation back towards normal levels is no longer the primary target.”
Reserves on the Rise
An increase of more than $15 billion in Turkey’s gross foreign reserves over the last three weeks -- following money transfers from Russia for the construction of a nuclear power plant -- may have given the central bank the confidence that it can wait out the pressures, especially as policy makers expect inflation to peak soon.
Kavcioglu has blamed a global rally in commodity prices, partly caused by Russia’s invasion of Ukraine in February. The central bank now predicts inflation will reach a high of around 85% this fall, before ending the year near 60%, or 12 times its target.
“Apparently, the increase in the Turkish central bank’s international reserves over the last month has emboldened the bank to cut the policy rate,” Per Hammarlund, chief emerging markets strategist at SEB AB, said, after the decision.
“Given the more favorable global backdrop -- namely falling interest rate expectations -- compared to earlier this year and inflows of capital from Russia, the cut is unlikely to cause an immediate confidence crisis in the lira. However, with inflation set to accelerate again in October or November, the lira will be in for a bumpy ride,” Hammarlund said.
Erdogan is intent on turbocharging growth by focusing on exports and employment as part of what he calls a “new economic model.” But risks abound as the cost-of-living crisis unfolding in Turkey poses a threat to his electoral popularity.
In place of higher rates, the central bank has rolled out macroprudential measures that helped slow loan growth momentum in July. It’s also relied on backdoor interventions and the introduction of state-backed accounts that shield savers from lira weakness.
The approach has allowed inflation to gallop near an annual 80% and left the lira vulnerable to a sell-off. The Turkish currency is among five of the world’s worst performers this year against the dollar, having lost around a quarter of its value.
Erdogan, long a believer that cheaper borrowing costs can slow inflation instead of pushing it higher, appointed Kavcioglu as governor of the central bank last year after ousting his three predecessors and seeking more sway over monetary policy.
An easing campaign by Turkey runs directly counter to what may prove to be the most aggressive tightening of monetary policy by central banks around the world since the 1980s.
“Cutting rates when the rest of the world is hiking and inflation is at decades highs is crazy,” said Henrik Gullberg, a macro strategist at Coex Partners Limited in London. “They will have to continue to intervene in markets, either directly or through state backed institutions to make sure lira is stable-ish. Most market participants will probably continue to expect the unexpected in the run-up to the elections next year,” he said.
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