In an unexpected move, Turkey's central bank increased interest rates just before critical local elections, aiming to counter a significant inflation surge projected to surpass 70%. This action reversed the lira's decline and sparked a positive response in the financial markets.
The central bank, under Governor Fatih Karahan, raised the one-week repo rate from 45% to 50%, a decision only Deutsche Bank AG had predicted. Other financial institutions like Goldman Sachs Group Inc. anticipated a smaller increase, while the majority did not foresee any change.
This rate hike is part of a broader strategy to combat inflation, with the central bank promising further tightening if inflation worsens significantly. They aim to establish disinflation in the latter half of 2024.
The decision led to a surge in banking stocks and strengthened the lira by up to 1.4% against the dollar. Additionally, Turkey's credit-default swaps saw their largest decrease of the year.
This policy shift marks a departure from Turkey's previous growth-focused strategy, which has been criticized for repelling foreign investment and causing currency crises. The rate increase was particularly surprising given its timing close to municipal elections, with President Recep Tayyip Erdogan historically favoring low interest rates.
Analysts view this move as a strong commitment to stabilizing the lira and adhering to orthodox economic policies. The central bank was compelled to act due to the lira's rapid depreciation and worsening inflation outlook, despite recently ending its tightening cycle.
Additionally, the central bank expanded its interest rate corridor, allowing for more expensive funding for commercial lenders. This adjustment serves as an emergency tool to manage the lira's value and inflation expectations leading up to the elections.
Despite this aggressive policy stance, questions remain regarding the central bank's recent unorthodox measures. However, a direct rate increase could encourage savings in lira assets and attract foreign capital back into Turkey.
Market participants have adjusted their year-end inflation expectations upwards, reflecting concerns over inflation's trajectory. This policy decision is seen as correct, given the recent inflationary pressures from higher wages and reserve losses.
