The Central Bank of Turkey on Thursday raised its main interest rate by 200 basis points, for the first time in two years, to support the Turkish lira, which is breaking record lower.
The main interest rate was raised to 10.25% from 8.25%, a move welcomed by the markets with an immediate rebound in the Turkish lira against the dollar after reaching an all-time low in the morning at 7.71 pounds against the greenback.
“A massive surprise, but positive,” commented Timothy Ash, analyst at BlueBay Asset Management.
The markets indeed expected the main rate to be maintained at its current level in the face of the institution’s reluctance to order increases due to President Recep Tayyip Erdogan’s opposition in principle to such a measure.
According to the Capital Economics Institute, the decision should “help restore the damaged credibility” of the Central Bank of Turkey.
The main interest rate had reached an unprecedented level of 24% in September 2018 when the Central Bank decided to raise it by 625 basis points in an attempt to stem the tumble of the Turkish lira and record inflation.
It has since been brought back below 10% thanks to a series of cuts decided by the Central Bank, encouraged to act in this way by President Recep Tayyip Erdogan who continues to hammer out his opposition to interest rates high.
Turkey, like many other countries, had kept interest rates low in recent months despite the fall of its currency in an attempt to support the growth of its economy hit hard by the Covid-19 epidemic.
– Reserves “almost exhausted” –
In a statement, the Central Bank explained its decision to raise rates by a desire to “restore the process of disinflation and support price stability”.
Turkey’s ambition is to bring inflation, which reached 11.77% in August, below 10% at the end of the year, a difficult objective to achieve if the local currency continues to fall.
Mr. Erdogan had tried to reassure the markets at the beginning of August when the Turkish free market had been in full free fall for several months already, but had not succeeded in permanently halting this downward cycle.
“I am convinced that the Turkish lira will stabilize. These things are temporary, variations occur all the time,” he said on August 7th.
Besides fueling inflation, the weakening pound is adding to the already crushing burden of foreign-denominated debt that weighs on many Turkish companies.
Moody’s rating agency said on Monday that Turkey’s foreign exchange reserves were “at their lowest level in 20 years.”
The institution downgraded Turkey’s credit rating to the speculative (“junk”) category of B2, to the same level as countries like Bolivia and Egypt.
“The government has almost exhausted the reserves that would allow it to avoid a possible balance of payments crisis,” she warned.
The Turkish head of state says he is convinced that high interest rates cause inflation instead of slowing it down.
For him, high rates are “the mother and father of all evil”.
According to experts, the Central Bank of Turkey should do even more to save the Turkish lira and claim political independence.
“They have not yet ruled out any risk,” said Ash. “But they gave each other a chance to fight.”