Turkey surprises with first interest rate hike in two years

Not a lot of people saw this one coming.

In a surprise move, Turkey’s central bank raised interest rates by 2 percentage points on Thursday to 10.25 percent – the first time in two years policymakers have increased borrowing costs.

The move is designed to reign in inflation and give a boost to Turkey’s embattled currency, the lira. But it also makes it more expensive for businesses to expand and consumers to spend on credit – which cools the economy.

The move was unexpected because of a perception among foreign exchange market participants that the government of Turkish President Recep Tayyip Erdogan would like the central bank to pursue policies that encourage economic growth.

One thing that is certain – the lira needed a helping hand from monetary policymakers.

The Turkish lira is down more than 20 percent this year and has been hitting record lows again this week, falling to 7.7 against the United States dollar.

Foreign exchange traders have punished the lira this year as Turkey has blown through foreign exchange reserves during the coronavirus pandemic. Soaring demand among Turks for hard currency has also contributed to lira weakness.

But news of the rate hike saw the lira strengthen to 7.5572  on Thursday before giving back some of those gains.

Roger Kelly, lead regional economist at the European Bank for Reconstruction and Development, described the surprise rise as a welcome and “bold” policy decision that illustrated that “lessons may have been learned” from Turkey’s 2018 currency crisis.

“With the lira steadily weakening in the face of real policy rates which are the lowest in the emerging market universe, and attempts to tighten policy using the interest rate corridor seemingly ineffective, the central bank needed to act,” he said.