“Terrible Decision”
Turkey’s central bank raises key interest rate only slightly
7/20/2023 3:44 p.m
The high inflation in Turkey persists. The central bank is now raising interest rates again, but not as much as expected. Economists are anything but enthusiastic.
The Turkish central bank has raised interest rates for the second month in a row in the face of persistently high inflation and the sharp depreciation of the lira. The monetary authorities announced that it would rise from 15.0 to 17.5 percent. However, economists had expected a stronger increase to 20.0 percent.
The central bank, under its new boss Hafize Gaye Erkan, initiated a trend reversal only last month and raised the key interest rate from 8.5 to 15.0 percent. She now signaled further steps. “The tightening of monetary policy will be further tightened in a timely manner and gradually as far as necessary until a significant improvement in the inflation outlook is achieved,” the central bank announced.
The unexpectedly small step met with criticism from economists. “A terrible decision,” said analyst Tim Ash from asset manager Bluebay Asset Management. “I think it’s a mistake.” Other experts expressed understanding. “There are serious concerns that moving too quickly could potentially jeopardize financial stability and disrupt the economy in general,” said Stuart Cole, chief economist at Equiti Capital. Economists assume that the key interest rate will rise to 25 percent by the end of the year. The unexpectedly small increase in interest rates was well received by equity investors. The leading index increased by 1.6 percent.
Inflation target a long way off
Although inflation fell more than expected in June, it remains very high at 38.21 percent compared to the same month last year. However, the central bank’s inflation target of five percent is still a long way off. The biggest price drivers include food and non-alcoholic beverages, which cost almost 54 percent more than in June 2022. “In our country, the latest indicators suggest that the underlying inflation trend is continuing to rise,” the central bank justified its interest rate decision.
The fight against inflation is made more difficult by the devaluation of the lira. The national currency has fallen 30 percent this year alone, marking a record low against the dollar this week. In 2021, the course had already fallen by 44 percent, and in 2022 by a further 30 percent. The country, which is poor in raw materials, has to purchase many goods from abroad, which have to be paid for in foreign currency. Higher interest rates make a currency more attractive to investors and can stop the price from falling.
Conventional wisdom has it that when inflation is high, higher interest rates help cool the economy, lower demand, and thus bring prices down. Head of state Recep Tayyip Erdogan refused this for a long time and relied primarily on increased production and growth. He put pressure on the Turkish central bank to prevent rising interest rates. After his re-election in May, he then appointed liberal economist Simsek and Wall Street banker Erkan. Both are regarded as advocates of conventional monetary policy.