Turkey makes bigger than expected interest rate hike, targets inflation

Turkey hikes interest rate to 25 percent, investors who say Ankara must move away from past policies welcome move.

The Turkish lira has weakened considerably against the dollar and other currencies in recent years, as Turkey's economy struggles [File: Dado Ruvic/Illustration/Reuters]

Turkey’s central bank on Thursday raised the interest rate to 25 percent in a surprise move that signals a continued move away from previous policy, which focused on keeping interest rates low.

The hike of 7.5 percentage points follows a raise to 17.5 percent from 15 percent last month.

Most economists had expected the bank to increase its policy rate Thursday to just 20 percent.

“Recent indicators point to a continued increase in the underlying trend of inflation,” the central bank said.

“Monetary tightening will be further strengthened as much as needed in a timely and gradual manner until a significant improvement in the inflation outlook is achieved,” it said.

The Turkish lira gained 1.5 percent against the dollar after the bank’s clear signal that it was stepping up its fight against inflation and attempts to support the troubled currency.

Capital Economics analyst Liam Peach said that the rate increase was “much larger-than-expected” and “will go a long way towards reassuring investors that the shift back to policy orthodoxy is on track”.

Many economists disagreed with Turkish President Recep Tayyip Erdogan’s previous monetary policy, which was regarded as unorthodox.

However, Erdogan infused his government with market-friendly faces after winning a difficult May election that came in the heat of one of Turkey’s most dire economic crises in decades.

They immediately set off on a new battle against inflation that peaked at an annual rate of 85 percent last October and is on the rise once again.

The team allowed the lira to start depreciating against the dollar in a bid to ease pressure on depleted state coffers.

They also imposed a series of more technical steps aimed at balancing the economy and restoring the trust of both consumers and Turkey’s foreign investors.

A new national approach to economics

The central bank increased its key rate to 15 percent from 8.5 percent at the first meeting chaired by former Wall Street executive Hafize Gaye Erkan in June.

Erdogan had pushed the nominally independent institution to slash borrowing costs out of a lifelong belief that high-interest rates cause, rather than cure, inflation.

But Erkan and Finance Minister Mehmet Simsek, a former deputy prime minister who returned to the cabinet in June, had advocated a more go-slow approach in the past two months that tried to restore market confidence without causing too much short-term pain.

That appeared to change when July’s annual inflation rate soared back to 47.8 percent thanks to billions of dollars in social spending Erdogan meted out during his election campaign.

The central bank expects the annual inflation rate to peak at 60 percent between April and June of next year.

“There remains a large gap between the policy rate and both current and expected inflation,” ING bank’s chief economist Muhammet Mercan warned.

Some analysts suspected that Erkan and Simsek feared a negative reaction from Erdogan should they push their reforms too strongly.

Erdogan fired one central banker four months into his attempts to raise interest rates in late 2020 and early 2021. He had previously dismissed two others for challenging his approach.

Source: Al Jazeera and news agencies