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Turkey’s central bank surprised markets again with its decision Thursday to cut its key interest rate, despite inflation in the country soaring above 80%.
The country’s monetary policymakers opted for a 100 basis point cut, taking the key one-week repo rate from 13% to 12%. In August, Turkish inflation reached 80.2%, accelerating for the 15th consecutive month and the highest level in 24 years.
Turkey also cut interest rates by 100 basis points in August and had gradually cut interest rates by 500 basis points by the end of 2021, sparking a currency crisis.
A statement from the central bank said it “assessed that the updated level of policy is adequate under the current outlook,” Reuters said. It said the cut was necessary as growth and demand continued to slow and also cited “escalating geopolitical risks”.
It said markets could expect the “disinflation process to begin” as a result of the measures taken, Reuters reported.
The policy direction has long baffled investors and economists, who say the refusal to tighten the policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long opposed interest rates and economic orthodoxy. reversed by insisting that lowering rates is the way to bring inflation down.
The months-long campaign to continually lower rates as Turkey’s trade and current account deficit widens and foreign exchange reserves run out has instead sent Turkey’s currency, the lira, into a multi-year downward spiral.
The lira has lost more than 27% of its value to the dollar so far, and 80% in the past five years. Following the announcement of the bank’s interest rate decision, the currency fell a quarter of a percentage point, trading at a record low of 18,379 for the dollar.
More danger for the lira
Many economists predict a further decline in the lira. London-based Capital Economics sees it fall to 24 against the dollar by March 2023.
“The scope for further easing is becoming increasingly limited due to the pressure it puts on the lira and real interest rates,” Liam Peach, the company’s senior emerging markets economist, told CNBC. “Turkey has such a large current account deficit and it has become dependent on foreign capital inflows to fund it. Currency reserves in Turkey are so low that the central bank is really not in a position to intervene.” , he said.
At some point, confidence will fall so low that those vital inflows will likely dry up, Peach warned: “Further cutting interest rates will make it harder for Turkey to attract those capital flows.”
Erdogan, meanwhile, remains optimistic and predicts that inflation will decline towards the end of the year. “Inflation is not an insurmountable economic threat. I am an economist,” the president said in an interview on Tuesday. Erdogan is not an economist by training.