Turkey’s central bank boosts credibility with interest rate hike

Turkey’s central bank raises interest rates by 2 percentage points – a bigger than expected move analysts say signals that the newly installed governor is setting monetary policy free of political pressure.

Turkey's new central bank chief Naci Agbal acknowledged last week that the lira's roughly 23 percent drop this year has kept inflation lofty, but the bank still sees it dipping to 9.4 percent by the end of 2021 [File: Nicole Tung/Bloomberg]

Turkey’s central bank increased interest rates by 2 percentage points to 17 percent on Thursday – a bigger than expected move, as it seeks to cool double-digit inflation and bolster its policy credibility under new Governor Naci Agbal.

The lira rallied to its strongest in more than a month and analysts said Agbal passed a test of his ability to set monetary policy free of political pressure after only two months on the job.

The bank, faced with record dollarisation and a weak lira, lifted its one-week repo rate from 15 percent. It again pledged to “decisively” keep policy tight to permanently lower inflation, which stood at 14 percent last month and has been above target for years.

“Agbal has totally passed the test” and showed the bank “is getting serious about inflation”, said Cristian Maggio, head of emerging markets strategy at TD Securities.

The lira – among the weakest of the emerging market currencies this year – rallied as much as 1 percent against the United States dollar and stood at 7.575 at 11:55 GMT.

The tightening follows a hefty increase of 4.75 percentage points last month, which was Agbal’s first move after taking the reins in a surprise leadership overhaul in which Turkish President Tayyip Erdogan pledged a new market-friendly economic era.

The “strong” tightening was meant to “eliminate risks to the inflation outlook, contain inflation expectations and restore the disinflation process as soon as possible”, the policy committee said in a statement.

Economists predicted a 1.5 percentage-point rise in a Reuters poll and called it a credibility test in the face of Erdogan’s past criticism of high rates, especially with coronavirus fallout set the crimp the economy this winter.

But inflation is rising and is well above the 5 percent target range, and Turks continue to buy foreign currencies at record levels, keeping Turkey’s lira near record lows and putting pressure on the bank to tighten again.

The bank said foreign exchange buying will reverse along with inflation.

Agbal acknowledged last week that the lira’s roughly 23 percent drop this year has kept inflation lofty, but the bank still sees it dipping to 9.4 percent by the end of 2021.

The lack of monetary stimulus could exacerbate an economic slowdown brought on by restaurant closures and new curfews after the pandemic’s first wave sharply contracted activity in the second quarter.

But the central bank is focused on inflation and its depleted foreign exchange buffer, which on a net basis is down by more than half this year due largely to costly state interventions in foreign exchange markets to support the lira.

Erdogan has long blamed high rates for inflation – in contrast to economic orthodoxy – and has held foreign investors responsible for the economy’s woes. But last month he said even “bitter” policies would be adopted.

TD’s Maggio said there will be more tests for Agbal because foreign investors have been deeply scarred by years of Turkish policies that squeezed them out of local assets.

In the 2018 crisis, the bank increased rates to as high as 24 percent.

Source: Reuters