Turkey: Central Bank surprises with major rate hike in September
At its monetary policy meeting held on 13 September, the Central Bank of the Republic of Turkey (CBRT) raised the one-week repo rate—which became the main policy rate on 1 June—from 17.75% to 24.00%, surprising market analysts who were banking on a more modest monetary tightening. The Bank’s decisive move—as opposed to the back-door tightening observed in recent weeks when the CBRT forced commercial banks to borrow at the overnight rate—provided some immediate relief for the battered lira and should go some way to restoring investors’ faith in the CBRT’s political independence. According to analysts at ING, “the CBRT has sent a strong message with its September decision in response to rising risks around price and financial stability.”
The significant monetary tightening came after inflation has risen alarmingly in recent months to stand at 17.9% in August, spurred by lira weakness. This is well above the Bank’s ostensible 5% target. In addition, firms’ inflation expectations have soared in tandem, and the huge currency collapse during August will fan cost-push price pressures going forward. According to the Bank, “recent developments regarding the inflation outlook point to significant risks to price stability. […] Deterioration in the pricing behavior continues to pose upside risks on the inflation outlook, despite weaker domestic demand conditions.” Moreover, the currency depreciation is heaping pressure on corporates by inflating their external debt burdens, which poses a risk to the banking sector. In this context—and even though such punitively high interest rates will depress economic activity—the Bank felt it appropriate to tighten its stance.
In its communiqué, the Bank made clear it was prepared to deliver further rate hikes if required. The extent to which this is necessary will depend in part on whether fiscal policy supports the disinflationary process; the medium-term program, to be presented by Treasury and Finance Minister Berat Albayrak this month, will be a key indicator in this regard. The future evolution of the lira will likely be another key determinant of the direction of monetary policy. The currency strengthened substantially on the CBRT’s decision, but a resumption of its downward trend would put pile pressure on the Bank to raise rates again.
The true extent of President Erdogan’s influence over monetary policy is still unclear. This latest decision, coupled with a sharp hike in May following a sudden currency decline, makes clear that the CBRT has the leeway to raise rates in times of economic distress. Despite this, with local elections in early 2019 and the economy already set to slow dramatically in H2, there could be political pressure for the Bank to hold off from further tightening.