Turkish Central Bank Takes U-Turn By Lifting Key Rate By 650 Bps To 15%

Turkey’s central bank raised its key interest rate for the first time in more than two years on Thursday, and massively, in the first meeting chaired by its newly appointed chief with the aim of establishing disinflation immediately and anchoring the inflation target.

The Monetary Policy Committee of the Central Bank of the Republic of Turkey, or CBRT, headed by the new Governor Hafize Gaye Erkan, decided to hike the policy rate from 8.5 percent to 15.0 percent.

However, that was far less than a raise to 21 percent that economists had forecast.

“Monetary tightening will be further strengthened as much as needed in a timely and gradual manner until a significant improvement in the inflation outlook is achieved,” the CBRT said.

The latest decision reverses an unorthodox economic policy pursued by President Recep Tayyip Erdogan. In the past, the Turkish leader favored low interest rates. But high inflation has forced the administration to re-think its economic policy.

The tightening move came after the second round of presidential elections in the country was held on May 28.

Recent official data showed that the country’s consumer price inflation eased to a 17-month low of 39.6 percent in May, but was still elevated and well above the target range of the central bank.

The strong course of domestic demand, cost pressures, and the stickiness of service inflation point to an increase in the underlying trend of inflation, the bank said.

In addition to these factors, the MPC anticipates that the deterioration in pricing behavior will put further pressure on inflation.

The committee will determine the policy rate in a way that will create monetary and financial conditions necessary to ensure a decline in the underlying trend of inflation and to reach the 5 percent inflation target in the medium term, the bank said in a statement.

“Further hikes are needed at the coming meetings to tackle Turkey’s inflation problem,” Liam Peach, an economist at Capital Economics, said.

“We still think that rates will rise to 25-30 percent later this year.”

The economist observed that a lot of optimism now seems embedded in Turkey’s financial markets and interest rate hikes to these levels are probably needed to sustain the reduction in Turkey’s risk premia that has taken place in recent weeks.

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