Turkey surprises with huge interest rate hike

ISTANBUL — Turkey's central bank on Thursday delivered a huge surprise by raising the interest rate to 25 per cent as part of a transition from President Recep Tayyip Erdogan's era of unorthodox economics.

The hike of 7.5 percentage points follows a raise to 17.5 per cent from 15 per cent last month.

Most economists had expected the bank to increase its policy rate Thursday to 20 per cent.

"Recent indicators point to a continued increase in the underlying trend of inflation," the central bank said.

"Monetary tightening will be further strengthened as much as needed in a timely and gradual manner until a significant improvement in the inflation outlook is achieved," it said.

The lira gained 1.5 per cent against the dollar in wake of the bank's strong signal that is was stepping up its fight against inflation and attempts to support the troubled currency.

Capital Economics analyst Liam Peach said the "much larger-than-expected" rate increase "will go a long way towards reassuring investors that the shift back to policy orthodoxy is on track".

Erdogan infused his government with market-friendly faces after winning a difficult May election that came in the heat of one of Turkey's most dire economic crises in decades.

They immediately set off on a new battle against inflation that peaked at an annual rate of 85 per cent last October and is on the rise once again.

The team allowed the lira to start depreciating against the dollar in a bid to ease pressure on depleted state coffers.

They also imposed a series of more technical steps aimed at balancing the economy and restoring the trust of both consumers and Turkey's foreign investors.

'Large gap'

The central bank increased its key rate to 15 per cent from 8.5 per cent at the first meeting chaired by former Wall Street executive Hafize Gaye Erkan in June.

Erdogan had pushed the nominally independent institution to slash borrowing costs out of a life-long belief that high interest rates cause — rather than cure — inflation.

But Erkan and Finance Minister Mehmet Simsek had advocated a more go-slow approach in the past two months that tried to restore market confidence without causing too much short-term pain.

That appeared to change when July's annual inflation rate soared back to 47.8 per cent thanks to billions of dollars in social spending Erdogan meted out during his election campaign.

The central bank expects the annual inflation rate to peak at 60 per cent in between April and June of next year.

"There remains a large gap between the policy rate and both current and expected inflation," ING bank's chief economist Muhammet Mercan warned.

Some analysts suspected that Erkan and Simsek feared a revolt from Erdogan should they push their reforms too strongly.

Erdogan fired one central banker four months into his attempts to interest raise rates in late 2020 and early 2021.

He dismissed two others before then for fighting his unorthodox approach.

Vote of confidence 

But Erkan's hand was strengthened following the appointment of three more respected economists to top central bank positions in the past month.

These bankers are "giving Hafize Gaye Erkan the backing to be more aggressive with rate hikes", emerging markets economist Timothy Ash said.

"The Turkish central bank now has a really impressive team in place — there is light at the end of the tunnel."

Erdogan gave his new team a new vote of confidence in prepared remarks delivered shortly after the decision.

"We are taking determined steps to address the problems caused by inflation," Erdogan said.

"We have started to see the positive impact of the measures already taken."