Erdoğan revives anti-rates talk before key meeting; lira slides

President Recep Tayyip Erdoğan reiterated his belief that higher interest rates cause inflation, sparking another decline in the lira just prior to a key central bank meeting.

In echoes of comments he made to investors in London in May, which precipitated a slump in the lira’s value, Erdoğan once again sought to re-draw economic theory by saying higher interest rates push inflation upward. The lira fell almost 3 percent against the dollar.

Erdoğan’s unconventional theories and increasing power over economic decision-making – he appointed his son-in-law as Treasury and Finance Minister in early July – are prompting investors to sell Turkish assets. The lira has slumped 40 percent against the dollar this year.

“Interest rates are the reason, inflation is the result,” Erdoğan said in a speech to small business owners in istanbul on Thursday, adding that rates should be cut.

The central bank will announce a decision on interest rates at 2 p.m. in Istanbul. Economists are expecting it to raise rates by 325 basis points to 21 percent, according to the average estimate in a Reuters poll. The central bank has failed to raise its benchmark rate since Erdoğan won a second term in office with increased powers on June 24 even as the lira continued to downward slide.

The lira dropped 2.8 percent to 6.52 per dollar at 12:47 p.m. in Istanbul after falling to as low as 6.56 against the U.S. currency.

Erdoğan said he has yet to see the central bank meet its inflation goal of 5 percent as it raised rates. The country’s financial institutions were “putting fuel on the fire” by increasing their own loan rates for the country’s businessmen, he said.

The most optimistic scenario is that the president's comments could be designed to shift the blame for a big hike in interest rates to the central bank, Turkish economy commentator Ugur Gurses said on Twitter.

The lira’s slump is hurting economic growth just as Erdoğan and his governing Justice and Development Party (AKP) prepare to fight local elections, which are due in March but could be brought forward. Quarter-on-quarter growth of 0.9 percent in the three months to June, reported earlier this week, is a precursor to an economic contraction and a possible full-blown recession, economists say.

Turkish inflation has surged to 17.9 percent from a little over 10 percent at the start of the year. A central bank poll of economists predicted that inflation would end 2018 at almost 20 percent.

A promise by central bank policymakers to “reframe” monetary policy last week has built confidence in financial markets that they will raise interest rates substantially at Thursday’s meeting.

In a latest move to tighten his grip on the economy, Erdoğan made himself chairman of the country’s sovereign wealth fund on Wednesday and replaced all of its directors. Earlier on Thursday, he barred Turks from using foreign currency in property and car-leasing contracts in a latest effort to steady the lira.

But foreign investors say the only way to reverse the currency’s 40 percent slide this year is to raise the benchmark interest rate decisively.

Goldman Sachs Asset Management is calling on the central bank to carry out a sizeable rate hike to restore its credibility. Many economists say it might need to take further action going forward to ensure the lira reverses course.

The bank in Ankara hasn’t raised its benchmark rate since early June, preferring to tinker with other lending rates to bring the average cost of funding to 19.25 percent. Erdoğan gave himself the power to appoint the central bank’s governor and his deputies in early July, and reduced their terms in office to four years from five.

Former Turkish central bank governor Durmus Yilmaz has joined investors in calling for a substantial rate hike, pointing to accelerating inflation. An increase in the order of 150 basis points just won’t do the trick and could spark a further slide in the lira, he said in comments carried by news website Sputnik.