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Lira gets a beating: Turkish central bank commits interest rate hara-kiri

Lira gets spanked
Turkey’s central bank commits interest rate hara-kiri

The financial world is surprised: Despite the extreme inflation, the Turkish National Bank lowers the key interest rate again. The lira immediately fell to a record low, but the move should particularly please President Erdogan, who describes himself as an enemy of interest rates.

Despite the inflation spiraling out of control, the Turkish central bank surprisingly lowered its key interest rate again. The key rate will be reduced by a full point from 13 to 12 percent, as the monetary authorities announced. Economists had expected an unchanged value. “It is important that financial conditions remain supportive in order to maintain the growth momentum in industrial production and the positive trend in employment,” the monetary authorities justified their unexpected move. The economy continued to lose momentum in the current summer quarter due to weaker foreign demand.

US Dollar / Turkish Lira 18:41

The Turkish national currency reacted immediately to the surprising measure: the lira slipped to a record low of 18.42 lira to the dollar. “With inflation at 80 percent, a rate cut is irrational,” Allspring Global Investment analyst Alison Shimada said of investors’ flight from the Turkish national currency. Capital Economics economist Liam Peach expects the rate to slip to 24 lira per dollar by the end of the year.

Textbooks recommend rate hikes

Inflation has skyrocketed lately. The inflation rate reached 80.21 percent in August, the highest level since 1998. According to the central bank’s forecast, the peak will not be reached until autumn, with inflation rates of almost 90 percent. The main reason for this development is the consequences of the Russian war against Ukraine, which has made many raw materials significantly more expensive.

However, rising inflation is also closely linked to the weakening lira: the national currency lost 44 percent of its value against the dollar last year, and more than a quarter so far this year. The reason for this, in turn, is that the central bank has gradually lowered its key interest rate from 19 to currently 12 percent since last autumn, although economic textbooks actually recommend interest rate increases when prices are rising sharply.

Falling interest rates make a currency less attractive to investors. The weak lira, in turn, makes imports more expensive, on which Turkey, which has few natural resources, is dependent. In such a situation, loosening the interest rate reins contradicts conventional economic doctrine. Such an unorthodox approach is supported by Turkish President Recep Tayyip Erdogan, who describes himself as an enemy of interest rates.

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