Turkey cuts interest rates again despite 80% inflation

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Russian tourists to Europe fell dramatically over the summer, but rose in several other destinations, including Turkey (here).

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Turkey’s central bank surprised markets once again with its decision on Thursday to cut its key interest rate, despite inflation in the country rising above 80%.

The country’s monetary policy makers opted for a 100 basis point cut, bringing the key one-week repo rate from 13% to 12%. In August, Turkish inflation was recorded at 80.2%, rising for the 15th consecutive month and the highest level in 24 years.

Turkey also cut interest rates by 100 basis points in August and had gradually cut interest rates by 500 basis points by the end of 2021, triggering a currency crisis.

A statement from the Central Bank of the Republic of Turkey said it has “assessed that the updated level of policy is adequate under the current outlook,” according to Reuters. It said the cut was necessary as growth and demand continued to slow, and also cited “escalating geopolitical risk.”

It said markets should expect the “disinflation process to begin” on the back of the measures taken, Reuters reported.

The policy direction has long puzzled investors and economists, who say the refusal to tighten policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long railed against interest rates and turned against economic orthodoxy by insist that lowering interest rates is the way to go. to bring down inflation.

People browse gold jewelry in the window of a gold shop in Istanbul’s Grand Bazaar on May 5, 2022 in Istanbul, Turkey. Gold prices ticked higher on Monday as the dollar hovered near recent lows, with investors focused on a key U.S. inflation gauge as it could affect the size of the Federal Reserve’s next rate hike.

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The month-long campaign to continuously lower rates as Turkey’s trade and current account deficits balloon and its foreign reserves run low has instead sent Turkey’s currency, the lira, into a multi-year tailspin.

the lira has lost more than 27% of its value to the dollar year to date and 80% in the last five years. Following the bank’s interest rate decision announcement, the currency fell a quarter of a percentage point to trade at a record low of 18.379 against the dollar.

More danger ahead for the lira

Many economists predict a further fall in the lira. London-based Capital Economics sees it falling to 24 against the dollar by March 2023.

“The room for further easing is becoming increasingly limited because of the pressure this is putting on the lira and real interest rates,” Liam Peach, the firm’s senior emerging markets economist, told CNBC. “Turkey has such a large current account deficit and it has become dependent on foreign capital inflows to finance it. Foreign exchange reserves in Turkey are so low that the central bank is really unable to step in,” he said.

At some point, confidence will run so low that these vital inflows are likely to dry up, warned Peach, “Cutting interest rates further makes it harder for Turkey to attract these capital flows.”

An electronic board displays exchange rate information at a currency exchange bureau in Istanbul, Turkey, Monday, Aug. 29, 2022.

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Erdogan, meanwhile, remains optimistic, predicting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview Tuesday. Erdogan is not an economist by training.

The Turks will likely continue to struggle as their basic living costs rise and Russia continues war in Ukraine has dramatically exacerbated commodity and energy price inflation globally.

But ultimately, said Erik Meyersson, senior economist at Stockholm-based Handelsbanken Capital Markets, “the most pressing problem is one of domestic economic mismanagement by the ruling regime.”

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