Turkey’s central bank aggressively raised its key policy rate by 475 basis points to 15% on Thursday at a highly anticipated meeting under a new governor in a bid to tame inflation and support the Turkish lira, which rallied following the move.
The hike met the market expectations and came after former Finance Minister Naci Ağbal was named the new chief of the Central Bank of the Republic of Turkey (CBRT) and after President Recep Tayyip Erdoğan pledged a more market-friendly economic approach.
The Monetary Policy Committee (MPC) raised the benchmark one-week repo rate from 10.25%, where it had stood since September.
“The committee has decided to implement a transparent and strong monetary tightening in order to eliminate risks to the inflation outlook, contain inflation expectations and restore the disinflation process,” the bank said in a statement following the move.
The uppermost rate, the late liquidity window – which had increasingly been used as the benchmark rate – was set at 19.5%, up from 14.75%.
But the bank said all funding will be provided through the 15% one-week repo rate, which will be the main policy tool and “the only indicator for the monetary stance.”
“This was absolutely the right and logical decision,” said Timothy Ash of BlueBay asset management.
“The bank has adapted to market conditions with the high rate of policy interest rate hike, strengthened its real interest position and increased predictability by directing all funding to a single rate,” Enver Erkan, an economist at Tera Yatırım, said in a statement.
The CBRT delivered “the long-awaited and needed aggressive rate hike ... in line with market expectations,” said Nikolay Markov, senior economist at Geneva-based Pictet Asset Management.
“The CBRT’s signal to markets is also very positive given its strong emphasis on its price stability mandate that becomes paramount. Therefore, the MPC will not hesitate to hike rates further if needed” Markov was cited as saying by Reuters.
Lasting fall in inflation
The bank said it was targeting a lasting fall in inflation.
"In the periods ahead, all factors affecting inflation will be taken into account, and the tightness of monetary policy will be decisively sustained until a permanent fall in inflation is achieved," the bank said.
It stressed that the permanent establishment of a low-inflation environment would positively affect macroeconomic and financial stability through the fall in the country risk premium, a reversal in the dollarization trend, accumulation of foreign exchange reserves and the perpetual decline in financing costs.
It also promised “transparency, predictability and accountability” in its inflation targeting program.
The country’s inflation increased to 11.89% in October, up from 11.75% in September, according to official data.
The bank last month raised its year-end inflation forecast to 12.1%, up from a previous forecast of 8.9%.
It also revised upward annual inflation for next year to 9.4% from 6.2% before stabilizing at around 5% in the medium term.
The bank identified the "lagged" effects of depreciation in the Turkish lira, as well as increasing international food prices and worsening inflation expectations as factors that have adversely affected the country's inflation outlook.
"While tracked data for November point to an increase in inflation due to the recent exchange rate volatility, this is assessed to be temporary with the decisive monetary policy stance," it said.
Ağbal himself said in his first public remarks last week that the bank’s main goal is to achieve and maintain price stability, and it will “decisively” use all policy tools in pursuit of this aim.
“In the next steps, the inflation outlook, ensuring the disinflation process and the exchange rate movement will continue to be the main determinants. Stability of the lira will be important in terms of controlling inflation expectations,” Erkan said.
He said that they consider “the harmonization of economic and monetary policy important in terms of issues such as maintaining credit growth in a controlled manner, establishing a balance in the growth/inflation equation and contributing to price stability.”
Thursday’s rate hike was the sharpest in more than two years and is expected to ease the double-digit inflation and support the lira, which rallied as much as 2.5% against the U.S. dollar following the move.
It was trading up 1.41% at 7.5980 against the greenback at 2:40 p.m. local time. The lira rallied some 12% last week.
“Overall, today’s decision and new policy commitment should be sufficient to stabilize the lira and the external imbalances in the coming weeks, thus preventing a balance of payments crisis for the time being,” Markov said.
Turkey’s sovereign dollar bonds hit fresh eight-month highs following the move, while five-year credit default swaps (CDS), a risk measure, slid to the lowest since March.
The country’s benchmark stock index BIST 100 surpassed 1,300 points with the backing of strong buying, up 0.9% from the previous close and 1,284 points from before the pre-hike level.
Erdoğan last week said even "bitter" policies would be adopted as he promised a new era of economic stability that welcomes foreign investors.
“Our aim is to reach single-digit inflation right away by maintaining fiscal discipline (and) implementing structural and micro-reforms” focused on growth and employment, the president said Wednesday. “We will solve the problems before us in a way that is in line with market economy rules.”
Erdoğan last week announced a series of new economic plans that will enable an improved investment climate for foreign investors backed by an efficient judicial system.
All 21 economists in a Reuters poll expected a rate hike with the median at 475 basis points and predictions ranging from 200 to 575 points. An Anadolu Agency (AA) survey of 27 economists also projected a hike ranging between 200 and 550 basis points.
Underlining that the recovery in economic activity continues, the bank said the partial restrictions introduced against the coronavirus pandemic amid rising infections heightened uncertainty in the short-term outlook on economic activity, particularly in the services sector.
"Besides, strengthening domestic demand, due to the lagged effects of strong credit impulse during the pandemic, affects the current account balance adversely through the imports channel."