Turkey’s central bank cuts rates despite rampant inflation

Turkey has cut interest rates for the second month running as president Recep Tayyip Erdoğan seeks to prioritise growth over financial stability ahead of next year’s elections.

The central bank announced on Thursday that it was lowering its benchmark one-week repo rate from 13 per cent to 12 per cent despite rampant inflation that exceeded 80 per cent in August.

The lira hit a record low after the announcement, falling to 18.387 against the dollar.

The decision to lower rates once again after a surprise rate cut last month pushes Turkey’s real interest rate — once inflation is taken into account — even deeper into negative territory to minus 68 per cent.

Atilla Yeşilada, a prominent economic commentator, said the move, which comes at a time when central banks around the world have been raising borrowing costs, showed that Turkey’s central bank had “gone off the rails”.

Ultra-low real interest rates are the centrepiece of Erdoğan’s deeply unorthodox approach to managing the $830bn economy as he prepares for a challenging bid for re-election next year.

The president, who is notorious for his rejection of the established economic wisdom that high interest rates help to tame inflation, has argued that he is pursuing a new economic model that will bring down inflation by prioritising exports, investments and jobs.

But his loose monetary policy has deterred local savers and foreign investors from holding lira or lira-denominated assets, heaping pressure on the currency.

Turkey’s ballooning external debt burden — with $182bn coming due in the next 12 months — and its wide current account deficit are further sources of demand for foreign currency that weaken the lira.

The weak currency, which has lost 27 per cent of its value against the dollar this year, has fed through into soaring inflation in a country that is heavily dependent on imports.

Authorities have sought to stabilise the currency by rolling out a serious of contentious measures, including a state-backed scheme aimed at encouraging savings in lira rather than dollars and a requirement for exporters to convert 40 per cent of their foreign currency revenues into local currency.

The central bank also continues to spend billions of dollars each month on intervening in the currency markets.

Recent rate cuts have not been fully passed on to households and companies. The average interest rate on consumer loans was about 31 per cent in early September, according to central bank data. Policymakers have also sought to direct lending to more productive sectors in a bid to stop uncontrolled credit growth.

Still, analysts warned that the fresh rate cut would pile renewed pressure on the lira. Robin Brooks, chief economist at the Institute of International Finance, an industry association, said a similar string of rate cuts in the autumn of 2021 “set off a cycle of uncontrolled lira depreciation”. He added: “The risk is that the same will happen now.”

Erdoğan’s hope is that cheap credit will sustain the country’s fast-paced GDP growth, which stood at 7.6 per cent in the second quarter of this year, to create jobs and a feel good factor in the run-up to next year’s polls.

But Selva Demiralp, a professor of economics at Istanbul’s Koç University, said that goal might be unachievable, arguing that “growth is not sustainable in an inflationary environment”.

“The rest of the world acknowledges that the costs of inflation on the economy are higher than the costs of reducing inflation,” she said. “But the Turkish central bank continues to remain detached from the rest of the world.”