Turkey surprises with interest rate cut as inflation soars

Turkey has shocked markets with a 100 basis point cut in interest rates despite inflation nearing 80%, as the central bank further eases policy to boost growth ahead of next year’s general election .

The bank was expected to hold the rate at 14%, which has already pushed Turkish real yields into deep negative territory, according to a survey by broadcaster Bloomberg HT. Instead, policymakers lowered the rate to 13%, saying they were concerned about the possibility of slowing economic growth.

“Leading indicators for the third quarter point to some loss of momentum in economic activity,” the bank said in a statement Thursday. “It is important that financial conditions remain supportive to preserve the momentum of industrial production growth and the positive employment trend in a period of growing uncertainties regarding global growth as well as escalating geopolitical risk.”

The lira fell about 1% to 18.14 against the US dollar, the weakest level on an intraday basis since a severe fall late last year.

The currency has fallen more than 25% in 2022 as inflation and deep concern over the central bank’s unorthodox monetary policy prompted foreign investors to flee the market.

Turkey has bucked the trend of other central banks raising borrowing costs to contain global inflation.

Şahap Kavcioğlu, the central bank governor, supports President Recep Tayyip Erdoğan’s unusual theory that high interest rates cause inflation, while mainstream economists take the opposite view.

“Instructions may have been given for a cut amid signs that growth may be slowing,” said Ceyhun Elgin, an economics professor at Bogazici University in Istanbul. “The goal may be to get things done, for better or for worse, until the election.”

Erdoğan’s ruling party has seen its support drop to historic lows amid widespread dissatisfaction with the cost of living in Turkey less than a year before the election. The president is betting that the weak pound will help manufacturers export more goods and that cheap credit will boost investment and jobs.

Kavcioğlu, who took over as bank chief last year, began easing monetary policy in September, cutting rates by 19%. It triggered Turkeythe highest inflation in a quarter century. Rates, through Thursday, had remained unchanged at 14% since December.

Line chart of TL per $ showing Turkish Lira breaches of 18 to the Dollar level

In recent weeks, the central bank has recorded a sharp rise in its foreign exchange reserves, helped by inflows from foreign governments, according to the finance minister.

That may have encouraged Kavcioğlu to cut rates again, giving the bank more buffer if it had to step in to support the pound, Elgin said. But the bank’s coffers remain about $61 billion in the red, when liabilities to other banks are taken into account, according to Goldman Sachs estimates.

“With this decision, Turkey’s central bank abandons any residual pretense of inflation targeting and reveals its overarching goal of supporting growth. With inflation at 80%, however, this recipe is just a disaster,” said writes Cristian Maggio, head of emerging markets strategy at TD Securities, in a note.

The central bank is officially targeting 5% inflation by the end of 2022.

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