Turkish lira hits fresh record low but central bank to avoid rate hike

(The story was updated with latest lira price in the third paragraph.)

Turkey’s central bank is poised to keep its benchmark interest rate unchanged this week even after the lira weakened to a fresh all-time low.

Economists say that pressure on the currency and the central bank’s dwindling foreign currency reserves mean its dovish monetary policy stance, backed by the government, is unsustainable and it will be forced to raise rates more than previously expected in the remainder of the year.

The lira hit a record low of 7.61 per dollar on Monday, weakening 0.8 percent on the day and extending losses this year to 22 percent.

President Recep Tayyip Erdoğan’s government has pressured the central bank to slash interest rates and then keep them unchanged to stimulate economic growth. That has meant monetary policymakers have been forced to defend the lira via other means as inflation accelerated and demand for imports widened the current account deficit.

The central bank is set to leave its benchmark interest rate of 8.25 percent unchanged at a monthly meeting of its Monetary Policy Committee on Thursday, according to separate polls of economists by Reuters and Bloomberg. But the bank will probably raise its average cost of funding by hiking interest rates for its so-called late liquidity window, they said.

U.S. investment bank Goldman Sachs said in a report that the central bank will probably raise the late liquidity window rate to 12 percent from a previous 11.25 percent at the meeting. Over the past few weeks Governor Murat Uysal has forced banks to borrow at higher rates of interest, raising average funding costs to 10.4 percent from 7.3 percent in July.

Erdoğan says higher interest rates in Turkey are inflationary, citing cost pressures for companies from more expensive borrowing. But this view contradicts conventional economic theory which states interest rates are a main tool of central banks for fighting inflation.

Consumer price inflation in Turkey stands at 11.8 percent, significantly higher than major emerging market peers. That means interest rates are negative when subtracting inflation. CPI slowed to as low of 8.6 percent last year as the central bank hiked borrowing costs to 24 percent and kept them elevated to defend the lira and stem price increases following a currency crisis in 2018.    

While predicting higher interest rates this year and in 2021, Goldman Sachs economists Kevin Daly and Clemens Grafe said there was a risk that the central bank would tighten policy too little, too late in its support for Erdogan’s economic growth programme.

Both Goldman and Deutsche Bank revised their predictions for an economic contraction in Turkey this year to lower levels, citing central bank policy and government stimulus, which has included issuing cheap loans via state-run banks. The lending splurge has sparked a borrowing boom, heightening concerns among investors for economic instability.

Goldman revised its estimate for an economic contraction this year to 3.5 percent from a previous 5 percent. Deutsche Bank said it expected gross domestic product to decrease by 2.5 percent in 2020, more than halving its forecast from 5.1 percent, Bloomberg reported on Monday.