Turkey hikes interest rates in another sign of economic normalcy. But markets expected more

Turkey’s central bank has raised its key interest rate in another sign of commitment to a traditional path of battling inflation

Turkey Interest Rates (Copyright 2023 The Associated Press. All rights reserved)

Turkey’s central bank raised its key interest rate Thursday, another sign of commitment to a traditional path of battling inflation but still falling below expectations after critics blamed President Recep Tayyip Erdogan’s economic policies for inflaming a cost-of-living crisis.

The 2.5 percentage point hike — putting the rate at 17.5% — came a month after the bank unleashed a 8.5% increase, a reversal after more than a year of rate-cutting prompted by Erdogan.

He believes lowering interest rates fights inflation, contradicting traditional economic theory that says the opposite. Central banks around the world have been hiking rates rapidly to battle spikes in consumer prices following the pandemic and Russia's war in Ukraine, but Turkey's bank started cutting rates in late 2021.

Since winning reelection in May, Erdogan has signaled a return to conventional policies by appointing two internationally respected economists to key positions.

Former Merrill Lynch banker Mehmet Simsek returned as finance minister, a post he held until 2018, while Hafize Gaye Erkan took over leadership of the central bank, the first woman in that position. She was previously co-chief executive of the now-failed San Francisco-based First Republic Bank.

Inflation in Turkey came in at 38% last month, down from an eye-watering high of 85% in October. Amid mistrust over official data, independent economists say inflation actually sits at 108%, leaving households struggling to afford basics like food and rent.

The central bank said it would keep raising borrowing costs “as much as needed in a timely and gradual manner” to ease inflation. But it fell short for markets.

The rate hike “once again underwhelmed expectations and the slow and steady tightening is pushing the limits on what policymakers can get away with,” said Liam Peach, senior emerging markets economist for Capital Economics.

Erdogan — a self-declared “enemy” of high borrowing costs — has said he would “accept” his new finance minister’s policies but also insisted that his views on interest rates have not changed. That led to questions about whether Turkey’s central bank could act independently.

Under pressure from Erdogan, the central bank had cut its key interest rate from around 19% in 2021 to 8.5% earlier this year. Erdogan has fired three central bank governors who resisted pressure to cut rates before appointing Erkan’s predecessor in 2021.

Economists say Erdogan’s unconventional belief has exacerbated economic turmoil, leading to currency and cost-of-living crises that have brought hardship to residents. Erdogan says his economic model prioritizes growth, exports and employment.

The Turkish lira has lost around 30% of its value against the U.S. dollar since the start of the year. Experts say the central bank has depleted its foreign currency reserves as it tried to prop up the currency ahead of May’s elections.