Turkey raises interest rates as it steps up decisive shift in economic policy

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Turkey’s central bank has sharply boosted interest rates in one of the clearest signs yet that its new economics team has decisively broken with years of unorthodox policy in an effort to stem runaway inflation.

The bank’s monetary policy committee on Thursday lifted the one-week repo rate by 7.5 percentage points to 25 per cent, far exceeding the 20 per cent forecast by economists in a FactSet poll.

The third rate rise in as many months underscores the dramatic shift in Turkey’s economic policies since President Recep Tayyip Erdoğan was re-elected in May. Central bank governor Hafize Gaye Erkan has nearly tripled interest rates since her appointment in June in an attempt to cool inflation.

“The Turkish central bank’s much larger-than-expected [rate rise] will go a long way towards reassuring investors that the shift back to policy orthodoxy is on track,” said Liam Peach at Capital Economics in London. “As far as Turkey’s macroeconomic outlook is concerned this could be a game-changer.”

Thursday’s decision was the first made since Erdoğan appointed three new deputy central bank governors. Like Erkan, the trio received a warm reception from investors because of their strong professional and academic credentials in finance.

The sharp tightening marks a shift from Erdoğan’s long-running insistence on holding interest rates low, which analysts say caused Turkey’s economy to overheat and helped send the lira tumbling. The currency bounced about 2 per cent higher against the US dollar on Thursday to TL26.77, but still remains near historic lows.

The central bank also warned that the weak lira, recent tax rises and minimum wage increases would contribute to a higher pace of price growth. It had forecast last month that inflation would reach nearly 60 per cent by year end from 48 per cent in July.

Mehmet Şimşek, a former City of London bond strategist who was appointed Turkey’s finance minister in June, said on the social media service X, formerly Twitter, after the rate decision that “price stability is our top priority”, adding that “we are determined”.

The rate increase followed a move by the government and central bank on Sunday to begin unwinding a $125bn scheme that compensates savers when the lira falls against foreign currencies such as the dollar and the euro. The decision was seen by many economists as a move both to shield Turkey’s public finances from fluctuations in the lira and a “back door” tightening in economic policy.

Economists are still broadly mixed on how much latitude policymakers have to unwind Erdoğan’s unconventional economic policies, especially with critical local elections looming next month.

“Whether President Erdoğan was on board with this decision is another matter and we simply can’t rule out Governor Erkan being sacked as a result of this move,” Peach said, alluding to how former central bank chief Naci Ağbal was fired after a series of rate rises in 2021.

Still, there are some signs that the new policies are beginning to pay off. The central bank’s gross foreign currency reserves, which dropped to unusually low levels ahead of the general election, have risen to $69bn from $48bn in May. Foreign investors have also pumped $1.7bn into Turkish stocks on a net basis since the start of June, central bank data show.