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Turkey's central bank surprised economists and investors on Thursday with a big hike in interest rates as policymakers sought to calm runaway inflation and stem accelerating capital flight among domestic savers.
The central bank raised the key interest rate by 5 percentage points to 50 percent. Most economists expected interest rates to remain stable before the local elections on March 31, according to a Reuters poll.
Policymakers noted a “deterioration in inflation expectations,” adding that “a tight monetary stance will be maintained until a significant and sustained decline in the underlying trend in monthly inflation is observed.”
The decision, which comes just weeks after Governor Fatih Karahan indicated that the central bank has likely ended the cycle of interest rate hikes, highlights how much Turkey's economic situation has deteriorated this year despite a sweeping policy overhaul that began in June.
The focus of the new program was to reverse President Recep Tayyip Erdogan's low-interest rate policies for years that sparked runaway inflation. The central bank has raised interest rates by 41.5 percentage points since Erdogan's re-election in May last year.
But other factors, including a 49% increase in the minimum wage this year, widely seen as a vote-winning measure ahead of this year's elections, and higher costs of imported goods due to the lira's decline, have made it difficult for the central bank to take action. decision on this matter. Control inflation.
Investors widely praised the new economic program, which was credited with steering Turkey away from a potential balance of payments crisis or even the imposition of capital controls.
However, many remain concerned about whether policymakers have moved quickly or far enough to win the battle against inflation – leading to renewed concerns as some of the data has worsened this year.
Consumer prices rose 4.5 percent in February compared to January alone, bringing the annual growth rate to 67 percent. The central bank expects inflation to rise towards 80 percent by the summer – close to its recent peak of 85.5 percent in 2022 – before falling to 36 percent by the end of the year.
“The decision to respond so quickly to the recent strong inflation numbers and raise interest rates before the local elections is clearly a very encouraging signal of a policy shift and should help maintain investor confidence,” said Liam Beach of Capital Economics, who expects further economic growth. Increase next month.
The Turkish lira rose against the dollar after the decision, causing the currency to rise by 0.7 percent to 31.92 Turkish liras in London trading. The country's dollar-denominated bond prices also rose, while the cost of protecting against debt default fell.
Thursday's rate hike will help close the wide gap between the inflation rate and the interest rates Turkish savers can earn from keeping the lira in their bank accounts, which has sent them scrambling to find alternatives, such as foreign currencies and stocks.
The total amount held by Turkish residents in foreign currency bank deposits rose by about $6 billion this year to $128 billion, according to the country's banking supervisory authority. The lira has fallen 8 percent against the dollar since the beginning of 2024 despite Thursday's gains.
Savers also expressed concern that the central bank, which many economists believe has kept the lira's losses steady in recent months, will allow it to fall more freely after local elections on March 31.
The central bank's foreign currency reserves, which have been replenished since the start of economic reform last summer, have begun to dwindle again as savers rush to buy dollars and euros.
Net foreign assets, the main proxy for Turkey's foreign currency 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 the Turkish Central Bank, wondered why policymakers had not indicated sooner that they planned to raise interest rates, as that would have stopped the outflow of reserves. But he said the decision was a “welcome step” and “will certainly help stop the erosion in the central bank's credibility.”
