Turkey facing economic headwinds as central bank considers rate hike

Turkey is facing headwinds to economic growth as the central bank considers increasing borrowing costs at a meeting next week.

Industrial output in the country expanded at the slowest pace on a monthly basis since the outbreak of the coronavirus in March, official data published on Friday showed. Production increased by 1.7 percent month-on-month in September compared with 3.4 percent in August and 8.4 percent in July.

Turkish President Recep Tayyip Erdoğan sacked and replaced the central bank’s governor at the weekend after the lira slumped to a record low against major currencies. Investors are now expecting the bank to hike the benchmark interest rate substantially to help underpin a rally in the currency this week and rein in annual inflation of 11.9 percent.

Manufacturing of non-durable goods in the country grew by just 0.6 percent month-on-month in September, the Turkish Statistical Institute said. Production of intermediate goods expanded by 0.7 percent.

Erdoğan said on Wednesday that he would back the central bank’s efforts to ensure price stability, saying the authorities may have to swallow a “bitter pill”. But the president also reiterated his view that higher interest rates cause faster price rises, saying that his government was on “an historic mission” to free the economy from the shackles of interest, the exchange rate and inflation.

Traders in the lira are taking Erdoğan at his word, believing he will not stand in the way of central bank policy despite his track record of seeking to grow the economy at the fastest pace possible. The bank is now led by Naci Ağbal, a former finance minister who had served as Erdoğan’s chief of strategy and budgetary affairs. He has a solid reputation among foreign investors.

The Turkish lira traded 0.4 percent stronger at 7.65 per dollar on Friday, extending a week-long rally to almost 9 percent.

The lira could rise to 7.4 per dollar and then strengthen further should the central bank not disappoint next week, Dutch bank Rabobank said.

The market has priced in a rate hike of 4.5 percentage points after Erdoğan signalled support for the central bank, said Chris Turner, global head of markets at ING Bank.

The central bank is expected to hike its benchmark interest rate by 4.75 percentage points to 15 percent at a meeting of its Monetary Policy Committee on Nov. 19, according to the median estimate of 13 economists in a Reuters survey published on Thursday.

The central bank has already raised the average cost of funding for banks to around 14.5 percent from 7.5 percent in July by lending at multiple rates of interest, imparting pressure on economic activity. Turkey's economy is expected to contract by 0.8 percent this year, according to an October survey of finance industry professionals and business leaders by the central bank. A November survey was due out on Friday.

Monetary policymakers were forced to triple Turkey’s benchmark interest rate to 24 percent in 2018 after a currency crisis swept through financial markets.

The rate hikes stabilised the lira but resulted in a sharp economic recession, causing disquiet in Erdoğan’s government. The central bank’s failure to lower rates swiftly once the currency crisis had subsided prompted Erdoğan to sack its governor in July last year.

There was better news for retail sales in the country on Friday. The volume of goods purchased by consumers increased by an annual 7.8 percent in September after 6 percent growth in August, the statistics institute said. The monthly increase was 2.8 percent, more than three times the August figure of 0.9 percent.

But demand for consumer goods in Turkey has widened its current account deficit alarmingly as imports outpaced exports. That has imparted further pressure on the lira.