(Bloomberg) -- Turkey’s central bank kept interest rates unchanged on Thursday and introduced new measures to tackle excess liquidity and curb lending in foreign currencies.

The Monetary Policy Committee led by Governor Fatih Karahan left the benchmark at 50% for a second consecutive month, in line with all forecasts. The MPC maintained its hawkish bias, repeating that its policy will remain tight “until a significant and sustained decline in the underlying trend of monthly inflation,” according to a statement.

The lira erased earlier losses and traded little changed as of 5:22 p.m. in Istanbul.

“Considering the lagged effects of the monetary tightening, the committee decided to keep the policy rate unchanged, but reiterated that it remains highly attentive to inflation risks,” it said. The central bank has hiked rates nine times in total since last June.

Shortly after Thursday’s rate decision, the central bank announced it will require commercial lenders to set aside more money as reserves for short- and long-term deposits.

It also imposed a cap of 2% on monthly foreign-exchange credit growth. Banks exceeding the limit will have to park cash with the monetary authority for a year.

Policymakers have been rebuilding their net foreign reserves at a sharp pace, pumping a huge amount of liras into the economy and threatening to undo some of the monetary tightening delivered by the central bank over the past year. 

Morgan Stanley has said that one consequence is “downward volatility in the interbank rate,” which is now near 47% from close to 53% earlier this month. In a sign of abundant lira liquidity in the financial system, the monetary authority has again become a net borrower of liras via open-market operations. 

“The key outcome of the improvement in the central bank’s FX reserves has been an increase in the banking system’s lira liquidity,” said Muhammet Mercan, ING Bank’s chief economist for Turkey.

The central bank also raised its reserve requirement ratios for the so-called FX-protected accounts, a move that facilitates a faster switch to regular lira deposits. Introduced as an emergency measure in late 2021 amid a currency crisis, the program has been a massive drag on Turkey’s international reserves.

‘Disinflation Path’

A longer rate pause by the central bank is key to sustaining the momentum of foreign inflows pouring into local assets as investors put their faith in Turkey’s efforts to return to more conventional economic policy bring down inflation that’s expected to peak soon around 75%.

Officials anticipate Turkey’s inflation, still among the world’s fastest, will start to slow from next month and end the year at 38%.

“A tightening in financial conditions and the additional tightening in monetary policy is expected to contribute to the return to the disinflation path,” said Haluk Burumcekci, an economist at Burumcekci Consultancy in Istanbul. Rates will likely stay at 50% for “a long time” given the limited fiscal measures so far, he said.

What Bloomberg Economics Says...

“The decision to complement a policy rate pause with liquidity steps lends support to our view that policymakers will further restrict financial conditions through revisions to its alternative measures and an active use of the interest rate corridor. The rate pause comes even as underlying inflation dynamics suggest a further increase is warranted.”

— Selva Bahar Baziki, economist. Click here to read more. 

Though Turkish nominal rates are the highest among the Group of 20 nations, they are still well below zero when adjusted for current prices. Turkish officials prefer to look at the differential between borrowing costs and the central bank’s projected path for inflation, a view that indicates policy is already tighter than would appear otherwise.

Should policy rates remain on hold for the foreseeable future, the focus will also increasingly shift to a planned fiscal adjustment and alternative tightening tools. Rate hikes also aren’t off the agenda quite yet, according to global banks including Morgan Stanley and HSBC Holdings Plc.

But consumer spending and sticky services inflation remain too strong for the liking of officials. The MPC said on Thursday that recent indicators pointed to “a slowdown in domestic demand compared to the first quarter.”

Looming monthly readings for inflation will probably dictate if the central bank tilts more hawkish and acts to keep prices from deviating away from its projected path.

“Assuming the currency follows a more stable course for the rest of the year with the continuation of the tight monetary stance, we expect inflation to be in the central bank’s forecast range with the central bank keeping the policy rate on hold at 50% for longer,” Mercan said. “We factor in a small cut by end-2024.”

--With assistance from Joel Rinneby.

(Updates with analyst comments starting in ninth paragraph.)

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