Turkey raises rates to 42.5 pct, approaching end of monetary tightening cycle

Turkey's Central Bank increased its key interest rate by 250 basis points to 42.5%, in line with expectations, in its efforts to combat persistently high inflation. However, the central bank also expressed its intention to conclude the aggressive tightening cycle at the earliest opportunity.


Turkey's Central Bank lifted its key interest rate by 250 basis points to 42.5% on Dec. 21 as expected as it faces down years of soaring inflation, but promised to end the aggressive tightening cycle as soon as possible.

Some analysts said one more rate hike was on the cards after seven straight months of tightening.

The central bank has lifted its one-week repo rate by 3,400 basis points since June, when President Recep Tayyip Erdoğan appointed former Wall Street banker Hafize Gaye Erkan as its governor to conduct a sharp pivot toward more orthodox policies.

It had raised rates by 500 basis points in each of the last three months but last month said tightening would soon end.

The graph is taken from Reuters Graphics.

After halving the pace on Dec. 21, it suggested it was even closer to the finish line by saying it expects to "complete the tightening cycle as soon as possible".

Monetary "tightness will be maintained as long as needed to ensure sustained price stability," it added, repeating that policy was "significantly close to the level required to establish the disinflation course."

Turkish lira was largely stable after the move, which brings the policy rate to its highest in two decades. The hike also edges real rates into positive territory, based on end-2024 inflation expectations.

All 12 respondents in a Reuters poll had expected the move to 42.5%. They forecast a bit more policy tightening early next year before easing in the second half.

The central bank expects inflation to rise from near 62% last month to 70-75% in May, before dipping to about 36% by the end of next year as tightening cools prices.

Selva Demiralp, professor at Istanbul's Koç University and a former Federal Reserve economist, said the policy level might be enough to rein in inflation if the bank avoids premature easing and capital continues to flow into Turkey next year.

"While we can estimate the central bank's reaction function... we cannot tell how much the central bank will be able to follow that route," she said.

"This is because we cannot estimate President Erdoğan's reaction function to monetary policy."

Erdoğan's past insistence on cutting rates despite rising prices sparked several currency crashes and sent inflation to two-decade highs. Though he backs the current policy, he has fired four central bank chiefs in as many years, raising questions over whether Erkan can stay the course.

In a sign of confidence that she can, Turkey's five-year credit default swaps, which measure default risk, dipped below 300 basis points this week from near 700 in May. JPMorgan told Reuters that Turkey could issue record debt in 2024.

The central bank "didn't close the door on the tightening cycle," said Nicholas Farr at Capital Economics, which expects another 250-point hike in January.

"Policymakers will need to keep interest rates high for an extended period if they want to bring inflation down to single digits," he wrote.

The policy U-turn is also meant to address chronic trade deficits and depleted foreign currency reserves and to attract foreign investors after a years-long exodus, for which there are signs of interest from big asset managers such as Amundi.

However, the high borrowing costs are already making it harder for Turks to roll over the debt they relied upon to deal with a cost-of-living crisis in the last two years.