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Turkey’s central bank surprised economists and investors on Thursday with a big interest rate hike, as policymakers seek to rein in runaway inflation and stem accelerating capital flight among local savers.
The central bank raised its key interest rate by 5 percentage points to 50%. A Reuters poll showed most economists expected interest rates to remain unchanged ahead of local elections on March 31.
Policy makers cited a “deteriorating inflation outlook” as the reason, adding that “the tight monetary stance will be maintained until we observe a significant and sustained decline in underlying monthly inflation.”
The decision, which came just weeks after Governor Fatih Karahan suggested the central bank had probably ended its rate-hiking cycle, highlights how badly Turkey’s economy has deteriorated this year despite a fundamental policy overhaul that began in June.
The centerpiece of the new program is a reversal of the low interest rate policy that President Recep Tayyip Erdoğan pushed for years and led to runaway inflation. Since President Recep Tayyip Erdogan was re-elected in May last year, the central bank has raised interest rates by 41.5 percentage points.
But other factors, such as this year’s 49% hike in the minimum wage (widely seen as a vote-getting tactic in the run-up to this year’s elections) and rising costs of imports due to the lira’s fall, make it difficult for the central bank to keep inflation at bay. grasp.
Investors have widely praised the new economic plan, which is believed to have helped Turkey avoid a potential balance of payments crisis and the imposition of capital controls.
But many remain concerned about whether policymakers have acted quickly or made enough progress to win the fight against inflation, and the deterioration in some indicators this year has led to renewed concerns. There are concerns.
Consumer prices in February rose 4.5% from January alone, for an annual growth rate of 67%. The central bank expects inflation to rise towards 80% by the summer, close to its recent peak of 85.5% in 2022, before falling to 36% by the end of the year.
Liam Peach of Capital Economics said: “The decision to react so quickly to the recent strong inflation data and raise interest rates ahead of local elections clearly sends a very encouraging signal for a change in policy and boosts investor confidence. It should help maintain it.” It will increase next month.
The Turkish lira strengthened against the dollar following the decision, gaining 0.7% to 31.92 in London trading. The price of the country’s dollar-denominated bonds also rose, while the cost of protection against default fell.
Thursday’s interest rate hike has left Turkish savers scrambling to find alternatives such as foreign currency and stocks to close the wide gap between inflation and the interest rates they can earn by holding lira in bank accounts. It would be helpful.
The total amount held in foreign currency bank deposits by Turkish citizens increased by about $6 billion this year to $128 billion, according to Turkey’s banking regulator. Despite Thursday’s gains, the lira has fallen 8% against the dollar since the start of 2024.
Savers also fear that the central bank, which many economists believe has stabilized the lira’s decline in recent months, will allow the lira to depreciate freely after local elections on March 31. ing.
The central bank’s foreign currency war chest has been replenished since economic reforms began last summer, but it is starting to dwindle again as savers scramble to buy dollars and euros.
Turkey’s net external assets, a key measure of foreign exchange reserves, fell to $7.2 billion this week from $30.8 billion in December, according to Financial Times calculations based on central bank data.
Hakan Kara, former chief economist at Turkey’s central bank, questioned why policymakers had not announced plans to raise interest rates sooner. That way, the outflow of foreign exchange reserves could be reduced. But he said the decision was a “welcome step” and “will definitely help stop the erosion of central bank credibility.”
