Turkish lira sinks to record low as Erdoğan says interest rates must be cut

Turkey’s lira plunged to fresh record lows against the dollar after President Recep Tayyip Erdoğan said interest rates must be lowered in July or August.

Erdoğan, who has sacked three central bank governors in less than three years, says that higher interest rates are inflationary, a view that jars with conventional economic wisdom that rate hikes are a key tool for tackling inflation.

The lira briefly tumbled more than 3 percent to beyond 8.8 per dollar late on Tuesday, when Erdoğan made the comments to state-run TRT television, before recovering. On Wednesday, it was trading down 0.8 percent at 8.59 per dollar.

“I spoke with our central bank governor today. It is imperative that we lower interest rates. For that, we need to see July or August for interest rates to start coming down,” Erdoğan said.

If Turkey reduces the burden of interest rates on investments, then it would remove cost-push pressures on inflation, he said.

Erdoğan spoke hours after local media reported that the central bank would hold two video conferences with local and foreign investors on Wednesday afternoon. The meetings were taking place ahead of the release of May inflation data on Thursday.

“You might have thought that he (Erdoğan) would have figured out by now that his comments on interest rates are terminal for the lira,” said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London.

Investors should not expect an early easing in interest rates, central bank governor Şahap Kavcıoğlu told investors in one of the video conferences, according to a copy of his presentation on the bank's website. The central bank is committed to keeping rates higher than actual and expected inflation, he said.

“Expectations for an early easing of policy, which aren’t based on a just reasoning, need to disappear,” Kavcıoğlu said.

The lira slid to a previous record low of 8.62 per dollar on Friday on concerns about global inflation and the prospect of rate hikes by the U.S. Federal Reserve. That renders riskier emerging market assets such as Turkish bonds less attractive to investors.

Inflation in Turkey accelerated to 17.1 percent in April, the highest level in major emerging markets after crisis-hit Argentina, from 16.2 percent in March.

Erdoğan removed former finance minister Naci Ağbal as central bank governor in mid-March after he hiked interest rates to 19 percent from 10.25 percent to slow inflation during a four-month tenure. The lira has lost almost 20 percent against the dollar since Ağbal’s departure.

The president replaced Ağbal, who earned the respect of foreign investors, with Kavcıoğlu, an economics professor who had no previous central bank experience. Kavcıoğlu has sympathised with Erdoğan’s unorthodox theory on interest rates and inflation. The central bank kept the benchmark rate at 19 percent at meetings in April and May, even as inflation accelerated.

Three other officials of the central bank’s seven-member monetary policy committee have been removed since Kavcıoğlu’s arrival.

Turkey’s central bank kept interest rates at below inflation for much of last year under Murat Uysal, another former governor. That allowed Erdoğan and his government to engineer a borrowing boom via a splurge in cheap lending by state-run banks.

The unorthodox policies forced the central bank to spend tens of billions of dollars of its foreign currency reserves defending the lira. The bank's reserves, net of liabilities such as currency swaps with state-run banks, now hover near minus $50 billion.

The central bank’s monetary policy committee is due to meet on interest rates on June 17.  

(This story was updated with central bank comment in the ninth paragraph.)