Turkey central bank juggles politics with economics, keeping rates on hold

Turkey’s central bank left its benchmark interest rate unchanged at 19 percent even after inflation accelerated and the lira lost value.

Central bank officials are seeking to reconcile the government’s desire for rate cuts with calls by foreign investors to keep monetary policy tight. Many economists have called for a rate hike to steady the lira and rein in double-digit inflation.

Turkey’s central bank’s credibility has been undercut over the past three years by President Recep Tayyip Erdoğan’s frequent meddling in monetary policy. Erdoğan, who says high interest rates are inflationary, has sacked three central bank governors since 2019.

The central bank said it would continue keeping rates at a level above inflation until strong indicators pointed to a permanent slowdown in price increases and a 5 percent inflation goal was reached. It did not provide details of that level in a statement accompanying the decision.

“I used to read central bank of Turkey policy statements. There is no point anymore,” Turgut Kışınbay, director of fixed income research at U.S. investment management firm Invesco, said in comments via his personal Twitter account.

“Best case scenario is the policy rate is on hold for a month," he said. "Hard to make a call beyond that. And a lot can change any day. Very low visibility.”

Consumer price inflation accelerated to 17.1 percent last month, the highest level in almost two years, from 16.2 percent in March. Turkey and crisis-hit Argentina are the outliers in emerging markets, which generally have single-digit inflation.

Governor Şahap Kavcıoğlu, appointed by Erdoğan in mid-March, is struggling to win the trust of foreign investors even after saying he will keep monetary policy tight. Economists point to inflationary pressures in the country and the sympathy Kavcıoğlu expressed with Erdoğan’s unorthodox theory on inflation prior to his appointment.   

The lira was trading up 0.1 percent at 8.3 per dollar after the decision. The currency has lost about 12 percent of its value since Kavcıoğlu replaced Naci Ağbal, a former finance minister who hiked rates from 10.25 percent during his four-month tenure. It hit a record low of 8.58 per dollar just prior to Ağbal’s arrival in November.

The decision matched the predictions of economists in polls by Bloomberg and Reuters. They all predicted no change. Two-thirds of economists expect a rate cut in the third quarter of the year, Reuters said.

The central bank “keeps wasting time hoping for better days”, said Wolfango Piccoli, co-president and director of research at Teneo, a New York-based political risk and advisory firm.

Kavcıoğlu said last week that he expected inflation to have peaked in April and that it would decline markedly in the second half of the year. The central bank raised its estimate for year-end inflation to 12.2 percent from 9.4 percent late last month.

Economists say any premature reduction in interest rates risks reinflaming inflationary pressures and hurting the lira.

"How can anyone trust central bank forward guidance when we know monetary policy is set in the presidential palace?" said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London.

Investors ' lack of confidence in central bank policy is reflected in the deteriorating outlook for the lira. The currency is expected to trade at 8.71 per dollar by the end of the year, about 5 percent lower than current levels, according to a monthly central bank survey of economic expectations. The forecast had stood at 8.57 per dollar in April and 7.78 in February.

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.

The central bank will probably "begin cutting rates in order to, more than anything, fulfil President Erdogan’s desire for looser monetary conditions," said Jason Tuvey, senior emerging markets economist at Capital Economics in London.

Tuvey said he expected the bank to lower rates to 14 percent by December.

(This story was updated with strategist's comments in the 14th paragraph.)