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Turkey’s central bank surprised markets once again with its decision Thursday to cut its key interest rate, despite inflation in the country surging beyond 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, Turkish inflation rate was recorded at 80.2%, quickening for the 15th consecutive month and the highest level in 24 years.
Turkey also cut rates by 100 basis points in August, and had gradually lowered interest rates by 500 basis points at the end of 2021, setting off a currency crisis.
A statement from the central bank said it has “assessed that the updated level of policy is adequate under the current outlook,” according to Reuters. He said that the cut was necessary as growth and demand continued to slow and also cited “escalating geopolitical risk.”
It said markets should expect the “disinflation process to begin” on the back of the measures taken, Reuters reported.
The policy direction has long stunned investors and economists, who say the refusal to tighten policy is a result of political pressure from Turkish President Recep Tayyip Erdogan, who has long railed against interest rates and turned against economic orthodoxy by insisting that lowering rates are the way to bring down inflation.
The months-long campaign to continuously lower rates as Turkey’s trade and current account deficit balloons and its foreign exchange reserves run low has instead sent Turkey’s currency, the lira, into a multi-year tailspin.
The lira has lost more than 27% of its value to the dollar year to date, and 80% in the last five years. Following the bank’s rate decision announcement, the currency was down a quarter of a percentage point, trading at a record low of 18.379 to the dollar.
More danger ahead for the lira
Many economists predict a further fall in the lira. London-based Capital Economics sees it falling to 24 against the greenback by March 2023.
“Room for further easing is becoming increasingly limited because of the pressure this is putting on the lira and real rates,” Liam Peach, the firm’s senior emerging markets economist, told CNBC. “Turkey is running such a large current account deficit, and it has become dependent on inflows of foreign capital to finance that. FX reserves in Turkey are so low that the central bank is really in no position to step in,” he said.
At some point, confidence will run so low that those vital inflows will likely dry up, Peach warned: “Cutting interest rates further makes it more difficult for Turkey to attract those capital flows.”
Erdogan, meanwhile, remains optimistic, predicting that inflation will fall by year-end. “Inflation is not an insurmountable economic threat. I am an economist,” the president said during an interview on Tuesday. Erdogan is not an economist by training.