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Turkey’s central bank surprised markets again with its decision on Thursday to cut its key interest rate even as inflation in the country soared above 80%.
The country’s monetary policymakers opted for a 100 basis point cut, bringing the key one-week repo rate from 13% to 12%. In August, inflation in Turkey was recorded at 80.2%, accelerating for the 15th consecutive month and the highest level in 24 years.
Turkey also cut interest rates by 100 basis points in August and gradually cut interest rates by 500 basis points at the end of 2021, setting off a currency crisis.
In a statement, the central bank said it “assessed that the updated policy level is adequate under the current outlook,” according to Reuters. It said the reduction was necessary as growth and demand continued to slow and also cited “escalating geopolitical risk”.
He said markets should expect “the process of disinflation to begin” amid the measures taken, Reuters reported.
The direction of policy has long puzzled investors and economists, who say the refusal to tighten policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long opposed interest rates and bucked economic orthodoxy by insisting that lowering interest rates is the way to bring down inflation.
The months-long campaign to steadily lower interest rates, as Turkey’s trade and current account deficits widen and its foreign reserves dwindle, has instead sent Turkey’s currency, the lira, into multi-year stagnation.
The pound has lost more than 27% of its value against the dollar year-to-date and 80% over the past five years. Following the announcement of the bank’s interest rate decision, the currency fell a quarter of a percentage point, trading at a record low of 18.379 to the dollar.
More danger lies ahead for the pound
Many economists predict a further decline in the lira. London-based Capital Economics forecasts a fall to 24 against the greenback by March 2023.
“The scope for further easing is becoming increasingly limited because of the pressure this is putting on the pound and real interest rates,” Liam Peach, the firm’s senior emerging markets economist, told CNBC. “Turkey has such a large current account deficit and has become dependent on foreign capital inflows to finance it. Turkey’s foreign exchange reserves are so low that the central bank is really unable to intervene,” he said.
At some point, confidence will fall so low that these vital inflows are likely to dry up, warned Peach: “Further cuts in interest rates make it difficult for Turkey to attract these capital flows.”
Meanwhile, Erdogan remains optimistic, predicting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview Tuesday. Erdogan is not an economist by education.