Turkey cuts interest rates again despite 80% inflation

The number of Russian tourists to Europe dropped dramatically during the summer, but rose in several other destinations, including Turkey (here).

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

The country’s monetary policymakers opted for a 100 basis point cut, bringing the key one-week buyback rate from 13% to 12%. In August, Turkish inflation reached 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 had gradually cut interest rates by 500 basis points by the end of 2021, sparking a currency crisis.

A statement from the Central Bank of the Republic of Turkey said it “considered that the updated level of policy is adequate under the current outlook,” according to Reuters. It said the cut was necessary as growth and demand continued to slow and also cited “escalating geopolitical risks”.

It said markets could expect the “disinflation process to begin” as a result of the measures taken, Reuters reported.

The policy direction has long baffled investors and economists, who say the refusal to tighten the policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long opposed interest rates and economic orthodoxy. reversed by insisting that lowering rates is the way to bring inflation down.

People browse gold jewelry in the window of a gold shop in Istanbul’s Grand Bazaar on May 5, 2022 in Istanbul, Turkey. Gold ticked higher on Monday as the dollar hovered near recent lows, with investors focusing on a key inflation measure in the US as it could influence the size of the next Federal Reserve rate hike.

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The months-long campaign to continually lower rates as Turkey’s trade and current account deficits mount and foreign exchange reserves run out has instead sent Turkey’s currency, the lira, into a multi-year downward spiral.

The lira has lost more than 27% of its value to the dollar so far, 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 for the dollar.

More danger for the lira

Many economists predict a further decline in the lira. London-based Capital Economics sees it fall to 24 against the dollar by March 2023.

“The scope for further easing is becoming increasingly limited due to the pressure it puts on the lira and real interest rates,” Liam Peach, the company’s senior emerging markets economist, told CNBC. “Turkey has such a large current account deficit and it has become dependent on foreign capital inflows to fund it. Currency reserves in Turkey are so low that the central bank is really not in a position to intervene.” , he said.

At some point, confidence will fall so low that those vital inflows will likely dry up, Peach warned: “Further cutting interest rates will make it harder for Turkey to attract those capital flows.”

An electronic board displays exchange rate information at a currency exchange office in Istanbul, Turkey on Monday, August 29, 2022.

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Erdogan, meanwhile, remains optimistic and predicts that inflation will decline towards the end of the year. “Inflation is not an insurmountable economic threat. I am an economist,” the president said in an interview on Tuesday. Erdogan is not an economist by training.

Turks are likely to continue to struggle as their basic living costs rise, and Russia’s ongoing war in Ukraine has dramatically exacerbated price inflation on goods and energy worldwide.

But ultimately, said Erik Meyersson, a senior economist at Handelsbanken Capital Markets in Stockholm, “the most pressing problem is one of domestic economic mismanagement by the ruling regime.”

Election planning?

Meyersson and other analysts view Erdogan’s decisions as primarily driven by elections next year.

“Given the upcoming elections, a disproportionate focus will remain on supporting short-term economic growth, putting further pressure on inflation and the lira,” he said. “The Turkish government’s ability to avert a deeper financial crisis may seem like a success, but its main failure has been the slow strangulation of the country’s economic potential.”

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Erdogan’s government has also launched several spending projects ahead of the election, including measures to ease energy bills and a major social housing project, said Can Selcuki, director of Istanbul Economics Research & Consultancy.

“I think you’ll see inflation rise more, but what the government had been counting on would be a deal with Russia to get cheaper gas to at least close the current account deficit on the energy side,” Selcuki said. referring to Erdogan’s frequent contacts with Russian President Vladimir Putin.

“But I think recent events have also jeopardized that deal, so I think we’ll see further devaluation of the lira and rising inflation,” he said.

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