Goldman says Erdoğan-led rate cuts to pressure inflation

Turkey’s central bank is expected to cut interest rates as much as possible this year, causing inflationary pressures to build, as it seeks to back President Recep Tayyip’s Erdoğan’s efforts to stimulate economic growth, according to Goldman Sachs.

The central bank may be forced to increase interest rates next year, reversing course after cutting them during the first three quarters of 2020, Goldman Sachs economists Murat Unur and Clemens Grafe said in a report, according to Bloomberg.

“The authorities will prioritise growth and reduce the policy rate as much as possible without destabilising the lira,” Unur and Grafe said. “Recent inflation dynamics and growth in money aggregates, in our view, also increase the risk of renewed lira volatility.”

Turkey’s central bank is expected to cut rates to 10.75 percent by the end of the first quarter from 11.25 percent currently, Goldman said, lowering its prediction from 11.5 percent after the bank reduced borrowing costs more than expected. The central bank, which next meets to decide on rates on Feb. 19, has slashed rates from 24 percent since Erdoğan sacked and replaced its governor in July for failing to support the government’s pro-growth policies.

“We were wrong in particular about how rapidly Turkey’s central bank could cut rates without undermining money demand or leading to renewed lira volatility,” the economists said.

Goldman saw the benchmark interest rate at 9.75 percent by the end of the third quarter, a level it was expected to hold until the end of the year.

Erdoğan says higher interest rates are inflationary, confounding traditional economic theory which states that interest rates should be raised to tame price increases.

Turkey’s lira fell to 6.05 per dollar on Friday, reaching its lowest level in regular trading since May, prompting the authorities to limit the amount of foreign currency swaps banks can conduct with foreign entities. The lira had slumped 28 percent in 2018 due to a currency crisis sparked by political tensions with the United States and concerns about economic overheating. It lost a further 12 percent of its value last year.

Inflationary pressures in Turkey now appear to be building. Consumer price inflation accelerated to 12.2 percent in January from 11.8 percent in December. The central bank’s target for inflation this year is 8.2 percent. Annual inflation may slow to 10 percent by December, according to a monthly central bank survey of bankers and businessmen conducted in January.

The central bank’s survey saw the lira at 6.41 per dollar by the end of the year and its benchmark interest rate at 9.9 percent in 12 months.