Turkey’s central bank raises interest rate to 15%

The Central Bank of Turkey on Thursday announced the start of tightening monetary policy, which investors had been expecting since the end of 2021 – then, instead of the traditional global practice of tightening policy in the face of rising inflation, the Turkish Central Bank, on the contrary, began to cut rates. On Thursday, the rate was almost doubled, by 6.5 percentage points, to 15%, while the regulator noted its readiness to fight inflation in Turkey further. Experts note that the Central Bank of this country will have to raise rates to 25-30% just to contain the weakening of the lira.

The Central Bank of Turkey, following a meeting on Thursday, sharply changed the direction of its monetary policy and raised the rate from 8.5% to 15%. This move, however, did not support the lira, which is weakening after the completion of the second round of the presidential elections in Turkey and the victory of Recep Tayyip Erdogan in it. On Thursday, the national currency of this country was trading at the rate of 24 lira per dollar – on the eve of the meeting, market participants predicted a more significant increase in the rate. It should be noted that the pressure on the lira rate is also exerted by signals from the head of the Fed, Jerome Powell, about the need to further increase rates in the US to combat US inflation.

The Turkish regulator on Thursday announced the need to start the fight against inflation “as soon as possible”, also stated the desire to influence the change in inflation expectations and the expectation of further pressure on price growth.

The regulator intends to tighten its policy in a “timely and gradual” manner and in the medium term to achieve a reduction in inflation to the target of 5%. In assessing the need for a further increase in the rate, the Turkish Central Bank will build on incoming data and adhere to a “transparent and predictable” policy, the statement said.

It should be noted that inflation in Turkey still significantly exceeds the level of the increased rate: in May, in annual terms, it slowed down to 39.6% from 43.7% in April and 50.5% in March. However, this effect is associated, among other things, with the high base of last year. Monthly inflation growth in May slowed down from 2.4% to 0.04%.

The meeting of the Central Bank of Turkey on Thursday was actually a “test” – after the appointment of a new cabinet of ministers and the change of the head of the Central Bank. It should be noted that the correction of the previous course began immediately after the elections. One of the key positions – the head of the Ministry of Finance – was given to an economist with experience in investment banks and a supporter of a moderate fiscal policy, Mehmet Simsek, who held this position in 2009-2015.

Mr. Shimshek promised that the government will seek to reduce inflation to single digits in the medium term, adhere to fiscal discipline and help the Central Bank in the fight against inflation.

Hafize Gaye Erkan, who previously worked mainly in American banks, including Goldman Sachs, became the head of the Turkish Central Bank.

The discrepancy between the levels of rates and inflation in Turkey began in the fall of 2021 – then inflation reached 20%, but the country’s Central Bank, under pressure from President Erdogan, who announced a “new economic model”, refrained from raising the rate. Its level, on the contrary, began to decline (in 2021 – from 19% to 14%, in 2022 – to 9%, in 2023 – to 8.5%), which is at odds with the generally accepted convention, which implies an increase in rates for slowdown in price growth. As a result, the gap between the rate and the inflation rate at the beginning of 2022 exceeded 50%, and in October last year, the price growth rate accelerated to 85%. After that, the indicator began to slow down due to the high base effect and lower energy prices.

“The rate hike upset investors who had expected more aggressive policy tightening, but the indication of further increases is reassuring to market participants,” Capital Economics said. Experts predict an increase in the rate by the end of the year to a level of 25-30%. Such a tightening will limit the unhindered depreciation of the lira.

Tatyana Edovina