Turkey shocks again by slashing rates 200 points despite soaring inflation

October 22, 2021

Ankara: Turkey's currency on Thursday plumbed record lows in response to a sharp interest cut that economists viewed as confirmation of the central bank's loss of independence from President Recep...

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Ankara: Turkey's currency on Thursday plumbed record lows in response to a sharp interest cut that economists viewed as confirmation of the central bank's loss of independence from President Recep Tayyip Erdogan.

The bank slashed its policy rate to 16 from 18 percent despite rising inflation and a fast-depreciating currency.

The lira lost more than 2.5 percent against the dollar after the announcement on fears that the decision could see inflation start to spiral out of control.The bank said there would be little room for more rate cuts this year given what it called transitory price pressure on food, energy and other imports, which have sent Turks' living costs soaring as the currency depreciated.

The central bank, under pressure from Erdogan who has replaced much of the bank's top leadership this year, also surprised markets last month with a 100-point cut that sent the lira tumbling to new depths.

Analysts called the latest cut reckless given it left Turkey's real yields sharply negative, and it runs against the grain of a world in which central banks are raising rates to head off a global inflation spike.

"The move is consistent with Erdogan's view, but his monetary policy is simply wrong and now we are running the risk of ... the real economy getting seriously hurt by the currency," said Ulrich Leuchtman, analyst at Commerzbank in Frankfurt.

"All this can only end in a lira crash," he said.

The lira weakened as much as 3% to a record 9.501 versus the dollar before paring some losses. It has shed 22% this year, with most of the drop since the beginning of September when the bank began giving dovish signals.

Erdogan has long called for monetary stimulus to boost credit, exports and jobs and has sacked the last three central bank governors in less than 2-1/2 years, eroding the bank's credibility and sending foreign investors fleeing.

A self-described enemy of interest rates, Erdogan fired three more monetary policy committee (MPC) members just last week - including two seen to oppose rate cuts - setting the stage for more easing.

After the policy meeting, the MPC said "supply-side transitory factors leave limited room for a downward adjustment to the policy rate until the end of the year."

"The sharp cut is completely unwarranted by the inflation outlook," the Oxford Economics consultancy said in a note to clients. The central bank "is clearly under orders to support growth at any cost," it said.

Erdogan has been pushing the policy-setting bank to cut interests rates in order to boost lending and promote investment and economic growth.

This expansionist policy has helped Turkey´s economy grow throughout the coronavirus pandemic and perform far better than its emerging market peers.

But the drawbacks have also been dire.

The lira has lost one fifth of its value against the dollar since the start of the year and the annual inflation rate has reached nearly 20 percent -- quadruple the government target.

Turks are converting their liras into foreign currencies and gold to try and preserve their dwindling savings as a result.

"The market will need some convincing to trust the lira again," ThinkMarkets analyst Fawad Razaqzada said after Thursday´s announcement.

The cut came in the face of growing calls from business leaders -- including Turkey´s largest industry association -- for the bank to regain its independence and focus on stabilising the exchange rate.

Erdogan is in danger of "dragging the Turkish economy into a president-made crisis," Eurasia Group said.

Turkey´s financial problems have been accompanied by an unusual spike in dissent from the country´s business community.

The Turkish Industry and Business Association issued a veiled swipe this week at Erdogan´s focus on achieving economic growth at all costs.

Opposition leader Kemal Kilicdaroglu also called on the bank on Thursday to "do what the economy requires" and "not take orders" from Erdogan. The central bank blamed rising inflation on "transitory" factors that will dissipate with time.

"The recent increase in inflation has been driven by supply side factors such as the rise in food and import prices, especially in energy, and supply constraints," the bank said.

"It is assessed that these effects are due to transitory factors," it added in its statement.

"The argument that inflationary pressures are only transitory just doesn´t cut it," said market analyst Craig Erlam at currency trading platform Oanda.

"The Governor is taking a gamble in order to appease Erdogan, while the serious central banks that don´t have a history of inflation problems are taking the risks more seriously," he added.

Erdogan is famous for his unorthodox belief that high interest rates cause inflation instead of helping tamp it down.

Conventional economic theory states the exact opposite is true.

Thursday´s interest rate cut was sharper than the one percentage point reduction expected by the market and the bank hinted that it may hold off on more reductions for some months to come.

But some economists warned that the damaged was already done.

"Insane monetary policy experiment going on in Turkey at present," BlueBay Asset Management economist Timothy Ash said in an email to clients.

"Think the message to Kilicdaroglu and the market is clear -- I listen to Erdogan and no one else," Ash wrote.

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