Lira rises nearly 7%! Türkiye raises interest rates by 750 basis points more than expected to the highest level in nearly two decades

Source: Wall Street News

The Turkish central bank unexpectedly raised interest rates by 750 basis points, raising the benchmark interest rate to the highest level in nearly two decades. The Turkish lira surged after hearing the news.

On Thursday, the Turkish Central Bank raised the one-week repo rate from 17.5% to 25%. This was the largest increase since 2018 and far exceeded market expectations. According to the median of a Bloomberg survey, economists generally expect a rate hike of only 250 basis points to 20%, and the last time official borrowing costs were higher than 25% was back in 2004.

After the news, Turkish assets rose sharply. The lira reversed its earlier decline and continued to expand to 7% against the US dollar, the largest increase in more than a year. The cost of insuring Türkiye's five-year debt against default fell below 400 basis points, and Turkish bank stocks soared, with the Borsa Istanbul Bank Index rising nearly 6%.

Turkey's Monetary Policy Committee said in a statement that the committee "decided to continue the monetary tightening process in order to establish an anti-inflation process as soon as possible, stabilize inflation expectations, and control the deterioration of price behavior."

This is the third consecutive rate hike since President Erdogan won re-election in May. Erdogan has promised a more orthodox monetary policy to counter the exodus of foreign investors in recent years.

In June this year, Turkey’s monetary policy officially turned. The Central Bank of Turkey announced a 650 basis point interest rate increase, raising the benchmark one-week repo rate from 8.5% to 15%. This is the first time Turkey has raised its benchmark interest rate since March 2021.

At that time, Erdogan changed the central bank governor and finance minister, appointing former First Republic Bank executive Hafize Gaye Erkan as the governor of the Central Bank of Türkiye. Erkan is Türkiye's first female central bank governor. She graduated from Princeton University and also worked at Goldman Sachs. At that time, the market expected that this would probably mean that Türkiye would change its unorthodox economic policies.

On July 20, the Central Bank of Türkiye announced that it would raise the benchmark interest rate by 250 basis points from 15% to 17.5%.

At the end of July, Erdogan appointed three new deputy governors, including a former adviser to the New York Fed and the former chief economist of one of Türkiye’s largest private banks.

Turkey’s real interest rates are still negative

Even if interest rates are raised significantly, Turkey’s real interest rates are the lowest in the world as inflation is currently close to 40%, and inflation-adjusted interest rates are still negative. Therefore, many investors believe that the Turkish central bank is still acting too cautiously.

ING said before Thursday’s resolution:

“The pace of policy tightening in recent months has disappointed the market.”

Analysts said Erkan’s approach poses a significant risk to the credibility of the Turkish Central Bank, especially after the central bank significantly raised its own inflation expectations last month. The central bank chief said price growth won't peak until the second quarter of next year, but showed no willingness to significantly raise policy rates.

In addition, the Turkish Central Bank has also taken other measures to increase funding costs. Its latest rules target a government-backed savings scheme designed to protect account holders from a falling lira.

Bloomberg Economics stated that the new regulations are equivalent to a "stealth interest rate increase". Previously, the Turkish Central Bank had decided to increase the bank deposit reserve ratio, which may actually mean tightening by another 40 basis points.

Goldman Sachs Group analysts Clemens Grafe and Basak Edizgil said in a report:

"The new measures may lead to an increase in lira deposit rates. However, as the gap between deposit rates and policy rates widens again, there is a risk of another withdrawal of funds."