Turkey cuts interest rates to push pound down as inflation soars

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Turkey’s central bank unexpectedly cut its benchmark interest rate on Thursday, despite accelerating inflation which had already made borrowing costs negative in real terms.

The pound fell more than 1.5% on the move, hitting an all-time low of 8.80 TL to the US dollar.

The bank’s monetary policy committee cut its key rate by one percentage point to 18%, surprising analysts who had predicted no change, according to Bloomberg and Reuters polls.

Inflation hit 19.25% last month. But Sahap Kavcioglu, who became central bank governor in March after his predecessor was sacked when he raised rates to support the currency, has come under pressure from President Recep Tayyip Erdogan to cut borrowing costs.

Kavcioglu’s appointment scared financial markets, fearing that he would pursue a lax monetary policy. The pound has fallen more than 15% since taking office, while inflation has remained in double digits for most of the past four years.

The central bank said it believed the rise in inflation was “due to transitory factors” while monetary policy had also “started to have a larger-than-expected contractional effect on commercial lending.” As such, he ruled that “a review of the stance of monetary policy is necessary and the key rate has been decided to be reduced”.

Kavcioglu, a former newspaper columnist, shares Erdogan’s unorthodox theory that high borrowing costs fuel inflation. He had repeatedly promised to keep benchmark rates above inflation, so investors could earn a premium on lira-denominated assets. The currency stabilized over the summer as foreign investors began to dip into lira-denominated government bonds.

But Erdogan has made it clear that he wants a cut by September, arguing that lower rates will hold back soaring prices. Kavcigolu signaled this month that a cut could come after he shifts the bank’s attention when setting rates to the lower core inflation figure, which does not include the prices of core inflation. food and energy.

“This is a crazy decision, a ridiculous decision,” said Tim Ash, emerging markets strategist at BlueBay Asset Management. “Inflation is high and rising, so there is no justification for this except politics. Erdogan is playing with the lire because he is losing popularity and is desperate to shake up the economy. It’s not a real central bank, it’s Erdogan’s stronghold.

Turkey’s $ 730 billion economy has grown at its fastest pace in at least two decades this year. Erdogan wants even faster growth as support for his ruling party falls to historically low levels in opinion polls. Polls show that Turks are very unhappy with the cost of living, their lack of jobs and the general state of the economy.

“Kavcioglu was well aware of what happened to previous governors who defied President Erdogan’s desire to cut rates and perhaps changed policies to save his job,” wrote Jason Tuvey, senior emerging markets economist. at Capital Economics, in a note to clients. .

Thursday’s decision, Tuvey added, would have “destroyed the credibility that Kavcioglu had built.”

In contrast, in a busy day for central banks, South Africa kept interest rates unchanged at 3.5% as expected, while Norway raised rates by 25 basis points from their lowest record of zero.