Turkey cuts interest rates again as the country struggles with inflation

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Turkey’s central bank surprised markets once again with its decision on Thursday to cut its key interest rate, despite the country’s inflation soaring to more than 80%.

The country’s monetary policymakers chose to cut 100 basis points, raising the one-week key repo rate from 13% to 12%. In August, Turkey’s inflation rate hit 80.2%, accelerating for the 15th consecutive month and the highest level in 24 years.

Turkey also cut interest rates by 100 basis points in August, and gradually lowered interest rates by 500 basis points at the end of 2021, triggering a currency crisis.

A statement issued by the central bank said that it “estimated that the updated level of the policy is sufficient in view of the current expectations,” according to Reuters. It said the cut was necessary as growth and demand continued to slow, and also pointed to “rising geopolitical risks”.

Reuters said that the markets should expect to “begin the process of lowering inflation” on the back of the measures taken.

The policy trend has long stunned investors and economists, who say the refusal to tighten policy is a result of political pressure from Turkish President Recep Tayyip Erdogan, who has long criticized interest rates and turned against economic orthodoxy by insisting that lowering interest rates is the way to go. to reduce inflation.

The months-long campaign to continually lower interest rates as Turkey’s trade and current account deficits decline and its foreign currency reserves drop has caused the Turkish currency, the lira, to slump for several years.

The lira has lost more than 27% of its value against the dollar in the year to date, and 80% in the past five years. Following the announcement of the bank’s interest rate decision, the currency fell a quarter of a percentage point, trading at a record low of 18.379 per dollar.

More danger to the lira

Many economists expect another drop in the lira. London-based Capital Economics sees it falling to 24 against the dollar by March 2023.

“The space for further easing is becoming increasingly limited due to the pressure this is putting on the lira and real rates,” Liam Beach, the company’s chief emerging markets economist, told CNBC. “Turkey has a large current account deficit, and it has become dependent on foreign capital inflows to finance it. Turkey’s foreign exchange reserves are so low that the central bank is not in a position to intervene,” he said.

At one point, Beech warned, confidence is so low that those vital inflows will likely dry up: “Reducing interest rates makes it more difficult for Turkey to attract those capital inflows.”

Meanwhile, Erdogan remains optimistic, and expects inflation to fall by the end of the year. “Inflation is not an insurmountable economic threat. I am an economist,” the president said during an interview on Tuesday. Erdogan is not an economist by training.

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