Turkey shocks markets with rate cut despite inflation nearing 80%

Turkish President Tayyip Erdogan arrives for a NATO summit in Madrid, Spain, June 29, 2022.

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Turkey’s central bank shocked markets on Thursday with a cut in its benchmark key rate, despite inflation in the country nearing 80%.

The country’s currency, the readdecreased by 0.9% compared to the dollartrading at over 18.1 against the greenback after the news – near a record low.

The country’s main key rate, which was 14% for the past seven months, has been reduced to 13%, in complete discordance with what other central banks in the world are doing.

“Another dumb move,” commented Timothy Ash, senior emerging markets strategist at BlueBay Asset Management.

“Insane with inflation at 80% and still rising, CBRT cuts rates, against expectations by 100 basis points to just 13%,” he wrote on Twitter, referring to Turkey’s central bank. by its acronym.

“Ridiculous decision. Obviously they have money in their pockets from Russia and the Gulf and think they can cut rates + hold the pound.”

The Turkish government pretended to diplomatic overtures to several oil-rich Gulf statesmending ties that were once strained to attract much-needed investment, and remained enthusiastically open to Russian business and trade despite Western sanctions and Russia’s invasion of Ukraine.

A man sells slippers at Eminonu on May 5, 2022 in Istanbul, Turkey. The country has grown rapidly for years, but President Erdogan has refused for years to raise rates significantly to calm the resulting inflation. The result was a plummeting Turkish Lira and much less purchasing power for the average Turk.

Burak Kara | Getty Images News | Getty Images

With analysts expecting no rate change, the central bank’s cut took markets by surprise. The main BIST index broke session gains to trade down 0.8% after the decision, although it then turned positive, up 0.2% in the next hour, the data showed. from Reuters.

The statement from Turkey’s central bank on Thursday said the committee expects “the process of disinflation to begin” and that there are signals of a “loss of momentum in economic activity.”

Turkey’s inflation for July rose 79.6% year-on-year, its highest level in 24 years, as the country grapples with soaring food and fuel costs and unorthodox strategy President Recep Tayyip Erdogan’s long-standing position on monetary policy. This time, five years ago, the lira was trading at 3.5 to the dollar; now it’s more than 18 to one.

“The Mother of All Evil”

Soaring consumer prices have hit the population of 84 million hard, and few have hopes of improvement anytime soon thanks to the Russia-Ukraine war, high energy prices and foodstuffs and a greatly weakened lira.

Turkey has grown rapidly in previous years, but Erdogan has in recent years refused to tighten policy significantly to calm the resulting inflation, describing interest rates as the “mother of all evils”. “.

The result was a plummeting currency and much less purchasing power for the average Turk. The lira has lost 26% of its value against the dollar since the start of the year and has fallen 80% against the dollar in the past five years.

Erdogan has asked the country’s central bank, which analysts say has no independence from him, to systematically cut borrowing rates in 2020 and 2021, even as inflation continued to rise. ‘increase. Central bankers who voiced opposition were fired; by spring 2021, Turkey’s central bank had seen four different governors in two years.

Capital controls?

The Turkish government is currently employing a range of unconventional methods to try to support the lira, most of which involve spending large foreign exchange reserves or blocking lira loans to companies deemed to hold too much foreign currency, which many economists warn is unsustainable.

There are likely more problems ahead for Turkey, London-based Capital Economics wrote in a note on Thursday. “This latest move could be the trigger for another currency crisis,” wrote Jason Tuvey, the firm’s senior emerging markets economist.

“It is clear that the CBRT is following its instructions from President Erdogan, whose unorthodox views form the basis of the government’s ‘new economic model’, with low real interest rates,” Tuvey said, adding that “the position Turkey’s external outlook remains extremely bad”.

The country, a key economic and political crossroads between East and West, home to millions of refugees from the Middle East and South Asia and NATO’s second largest army, is also suffering from a growing current account deficit, “large short-term external debts and dangerously low foreign exchange reserves,” Tuvey wrote.

“If the CBRT is to pursue further rate cuts over the next few months, we suspect it will turn to more restrictive capital controls.”

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