Turkey’s central bank on Thursday surprised markets with a bigger than expected rate hike to battle soaring inflation and boost the lira, prompting the embattled currency to surge in value.
Turkey has in recent weeks been battling through one of the most troubled periods for its economy under the rule of President Recep Tayyip Erdogan, with the lira battered on currency markets in August.
The Turkish central bank on Thursday hiked the one week repo auction rate 625 basis points from 17.75 per cent to 24 per cent, significantly higher than the Bloomberg consensus of 21 per cent.
The lira reacted strongly to the decision, rising by five per cent in value to 6.0 lira to the US dollar. It later shed some of those gains but was still up over 2.7 per cent in value at 6.15 to the dollar.
The magnitude of the hike was all the more surprising given that just before the decision President Recep Tayyip Erdogan had slammed interest rates as a “tool of exploitation”.
The bank had not touched interest rates since early June with markets concerned that the policy of the nominally independent bank is being dictated by Erdogan.
There had been indications from the bank that it would raise rates after inflation came in at nearly 18 per cent in August, according to official data last week.
The bank said on Thursday that inflation developments pointed “to significant risks to price stability” due to the recent fall in the value of the lira.
The bank vowed the tight stance in monetary policy would be “maintained decisively until inflation outlook displays a significant improvement” in the statement.
It described the hike as a “strong monetary tightening to support price stability”.
The bank must balance concerns over slipping growth, which, although a robust 5.2 per cent in the second quarter on an annual comparison, showed signs of weakness with some analysts predicting Turkey is heading for recession.
“Deterioration in the pricing behaviour continues to pose upside risks on the inflation outlook, despite weaker domestic demand conditions,” the bank added.
Economists have argued the nominally independent bank has come under pressure from Erdogan who, only a couple of hours before its decision, launched a blistering attack on the bank and described interest rates as a “tool of exploitation”.
He earlier charged the bank with failing to control inflation and again aired his unorthodox view that low rates bring inflation down.
“Interest rates are the cause, inflation is the result. If you say ‘inflation is the cause, the rate is the result’, you do not know this business, friend,” he added.
The bank implemented what economists described as a hidden interest rate hike in mid-August, forcing banks to borrow at the higher 19.25 per cent through the overnight lending facility.
The bank later said on Twitter that funding would be provided via the policy rate, the one week repo auction rate, instead of through overnight lending from September 14.
Analysts say the lira’s plunge last month had been sparked by a combination of concerns over domestic policymaking and a crisis in relations with the United States (US).
As well as being seen to undermine the independence of the central bank, Erdogan in July stunned markets by appointing his son-in-law Berat Albayrak as finance minister.
Relations with the US deteriorated last month after Washington imposed sanctions on two Turkish ministers over the detention of an American pastor and President Donald Trump doubled steel and aluminium tariffs on Turkey.