Turkey’s dovish central bank to keep rates steady even after inflation spikes

Turkey’s central bank, shackled by political pressure, is expected to leave its benchmark interest rate unchanged on Thursday even after inflation accelerated to the highest level in almost two years.

Economists are unanimous in the prediction, according to surveys by Reuters and Bloomberg. The central bank’s benchmark rate stands at 19 percent.

Investors say a change in the central bank’s leadership - President Recep Tayyip Erdoğan sacked and replaced its governor in March – means monetary policymakers’ hands are tied in dealing with inflation, which climbed to 17.1 percent in April, the highest in emerging markets outside of crisis-hit Argentina, from 16.2 percent in March.

Erdoğan, who has sacked three central bank governors since July 2019, says higher interest rates fuel inflation rather than reduce it, a view that jars with conventional economic theory.

All 18 economists surveyed by Reuters last week predicted no change in rates. Twenty-four economists questioned by Bloomberg unanimously forecast the same outcome. Two-thirds of economists see a rate cut in the third quarter, Reuters said.

“The central bank looks set to keep rates on hold today, despite strong inflationary pressures and markets not buying the bank's inflation forecast,” Erik Meyersson, an economist and former assistant professor at the Stockholm Institute of Transition Economics (SITE), said in comments on Twitter.

The central bank appears to be gearing up to meet Erdoğan's desire for a rate cut in the coming months.

Governor Şahap Kavcıoğlu said last week that inflation probably peaked in April. A slowdown in price increases will accelerate in the second half of the year he said. He pledged to keep interest rates at a margin above current and expected inflation, without providing further details.

Inflation in Turkey is spiking after the lira slumped against the dollar over the past year. The losses have accelerated after Kavcıoğlu replaced Naci Ağbal, a former finance minister respected by foreign investors. Ağbal had hiked rates from 10.25 percent during his four-month tenure and had promised to keep them elevated throughout the year.

Producer price inflation surged to 35.2 percent last month, the highest level since a currency crisis in 2018. The price of intermediate goods rose by an annual 42.6 percent and energy costs by 38.6 percent.

Kavcıoğlu sympathised with Erdoğan’s unorthodox theory on the relationship between interest rates and inflation prior to his appointment. During a discussion with economists and journalists last week, he did not respond to a question about whether he could persuade Erdoğan about a rate hike.

“I see inflation peaking at well over 19 percent and Kavcıoğlu’s promise to keep real rates positive will then be tested,” Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London, said in e-mailed comments.

Two other members of the central bank's seven-member monetary policy committee have been replaced since Kavcıoğlu's arrival. 

Losses for the lira have also been spurred by the government’s wider economic policies. Erdoğan has prioritised economic growth over inflation. Last year, his government ordered state-run banks to lend at below market rates to engineer a borrowing boom and the authorities coerced other lenders into doing the same with new rules and incentives.

The central bank, under then-governor Murat Uysal, kept interest rates at below inflation to back government policy while spending tens of billions of dollars of its foreign currency reserves defending the lira. The political opposition claims $128 billion of the reserves were wasted, a claim Erdoğan and his party strongly reject, and has called for a full parliamentary investigation.

Erdoğan dismissed Uysal in early November after the lira hit a record low of 8.58 per dollar. The currency was trading 0.3 percent weaker at 8.33 per dollar on Thursday ahead of the central bank’s rate-setting meeting.