Turkey’s central bank unexpectedly hiked interest rates by 200 basis points to 10.25% on Thursday, tightening policy for the first time in two years in order to lift the lira from record lows and rein in elevated inflation.
The currency had slid as much as 23% against the U.S dollar this year as concerns grew over the central bank’s depleted reserves, costly state interventions in the forex market, and surging demand from Turks for hard currencies.
The bank was widely expected to hold policy steady, in part because of perceived pressure for stimulus from President Tayyip Erdogan’s government. But it said a fast economic recovery from the initial coronavirus shock had kept prices too elevated.
“Inflation followed a higher-than-envisaged path,” its policy-making committee said. The rate hike was needed “to contain inflation expectations (and) restore the disinflation process.”
Only three of 17 economists in a Reuters poll had predicted the bank would raise its key one-week repo rate <TRINT=ECI>, with most expecting it to continue with back-door measures to tighten the money supply.
The lira <TRYTOM=D3> firmed to as much as 7.56 against the dollar after the rate announcement, from around 7.71 beforehand, its strongest intraday rally in about a month. It was up 1% at 7.6150 at 1153 GMT.
The policy rate remains below the 11.77% annual inflation rate, leaving real rates negative for lira depositors.
Roger Kelly, the lead regional economist at the European Bank for Reconstruction and Development, said the “bold” policy decision was welcome and showed “lessons may have been learned” from a 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.
The policy rate had been held at 8.25% since May — in the middle of Turkey’s coronavirus lockdown — following a nearly year-long aggressive easing cycle that chopped it down from 24%.
As the lira declined over the past two months, the central bank resorted to back-door measures that lifted the weighted average cost of funding <CBTWACF=> to 10.65% as of Wednesday, from a low of 7.34% on July 16.
Tensions with Greece and the European Union over exploration rights in the east Mediterranean have also weighed on the lira, though the risk of sanctions eased this week.
The rate hike “is a step in the right direction”, said Kieran Curtis at Aberdeen Standard Investments, although he added the lira was still vulnerable given market skepticism that the government had the appetite to continue tightening.