Turkey makes negative interest rates official policy after inflation revision

Turkey’s central bank has made negative real interest rates official policy by revising its inflation forecast upward.

The central bank estimates that consumer price inflation will be 8.9 percent by the end of the year, Governor Murat Uysal said at a news conference in Ankara on Wednesday. The forecast, increased from 7.4 percent, is now higher than the bank’s benchmark interest rate of 8.25 percent.

Uysal indicated that the bank had no plans to raise interest rates to help slow inflation, saying its monetary policy was in line with its price estimates. Instead, Uysal said he expected inflation to enter a downward trend from this month. It stood at 12.6 percent in June.

Turkey’s central bank is under political pressure to keep interest rates low or negative, prompting some investors to forecast that monetary policymakers will not be able to raise borrowing costs even if inflation spikes. Those predictions have helped spark a foreign exodus from Turkey’s bond and stock markets and sent the lira to record lows.

Turkish President Recep Tayyip Erdoğan sacked Uysal’s predecessor Murat Çetinkaya in July last year for failing to support his pro-economic growth policies. Under Çetinkaya, the central bank had hiked interest rates following a currency crisis in 2018 and then left them on hold to help stabilise the lira and the economy.

But since Uysal’s arrival last July, the bank has slashed interest rates from 24 percent. Erdoğan maintains that higher interest rates are inflationary, a view that jars with conventional economic theory, which says they can be used as a tool for controlling inflation.

Uysal said he expected Turkish inflation to slow to 6.2 percent by the end of next year, which is unlikely, given historical inflation and the bank’s current policies.

Turkey’s central bank has never met its official medium-term inflation goal of 5 percent since it was introduced about a decade ago. The lowest year-end inflation rate over the past 10 years was 6.2 percent, set in 2010. In 2019, the bank forecast year-end inflation of 6.7 percent, only for it to end the year at 11.8 percent.

The central bank’s revised inflation forecast for 2020 is still well below market expectations. Bankers see consumer price inflation slowing to 10.2 percent by December, according to a monthly central bank survey of expectations published in July. They predict inflation slowing to 8.4 percent in two years, still above the central bank’s 2021 goal.

The bank’s dovish approach to inflation comes amid renewed pressure on the lira. The lira slumped to a record low of 7.269 per dollar in early May. It fell 0.4 percent to 6.95 per dollar on Wednesday afternoon, extended losses to 13 percent since Jan. 1. Analysts are predicting more weakness.

The central bank’s announcement on prompted Tim Ash, a veteran Turkey-watcher and senior emerging markets strategist for Blue Bay Asset Management in London, to urge it to take a “101 monetary policy course”, pointing to the impact on the lira of low real interest rates.

Foreign investors have fled Turkey’s bond and stock markets this year on concerns about unorthodox monetary and economic policy. They now own less than half of the shares on Turkey’s stock market for the first time in more than a decade and a half.

Any decline in the price of the lira against major currencies puts pressure on inflation – Turkey is a big importer of consumer goods, which become more expensive as the lira falls, and imports nearly all the oil and natural gas it consumes. Imported goods and raw materials also make up more than two-thirds of finished exported goods by Turkish firms.

The central bank’s support for Erdoğan’s pro-growth economic policies has meant that it has been forced to spend tens of billions of dollars of its foreign currency reserves this year supporting the lira. Banks traditionally increase interest rates to help halt currency weakness. But the central bank has few, if any, foreign currency reserves remaining when taking account of its forex liabilities.

The bank has kept interest rates low, allowing Erdoğan’s government to flood the economy with cheap loans from state-run banks to help boost economic growth. That policy has led to a boom in demand for credit and prompted ratings agencies including Standard & Poor’s to warn of imbalances in the economy.

Speaking to the New York Times on Tuesday, Maya Senussi, a senior economist at Oxford Economics, said Turkey’s economic policies meant that the country could soon plunge into more financial turmoil.

The economy is “only one shock away from a crisis,” Senussi said