Turkey’s Central Bank Cuts Rates Again at the Lira’s Expense

(Bloomberg) -- Powered by President Recep Tayyip Erdogan’s unorthodox monetary ideas, Turkey’s central bank delivered a bigger-than-expected interest-rate cut on “transitory” inflation, adding that it has limited room left for further reductions this year. 

The lira slumped to a record low.

The Monetary Policy Committee reduced its key one-week repo rate by 200 basis points to 16%. All 26 economists surveyed by Bloomberg expected Governor Sahap Kavcioglu to continue monetary easing after Erdogan fired policy makers opposed to his calls for lower borrowing costs. But most forecast a reduction of 100 basis points, with a sizable minority expecting half of that.

The “recent increase in inflation has been driven by supply side factors,” the central bank said, calling them transitory. “The Committee assessed that, till the end of the year, supply side transitory factors leave limited room for the downward adjustment to the policy rate.”

The lira dropped as much as 2.9% and was trading 2.3% lower at 9.4299 per dollar at 3:11 p.m. in Istanbul. The currency is down over 20% this year, more than any other major currency tracked by Bloomberg.

After the rate cut, which brought the real yield to negative 3.58%, option traders now see a more than 70% chance that the currency will weaken to 9.50 over the next week, a new low and the next psychological threshold, according to Bloomberg pricing.

A self-described “enemy” of high interest rates, Erdogan espouses the unconventional hypothesis that reducing them will lead to lower inflation. He appointed Kavcioglu in March, replacing hawkish predecessor Naci Agbal after back-to-back rate hikes. Kavcioglu kept policy unchanged for nearly six months before unexpectedly cutting the benchmark rate by 100 basis points to 18% in September, when consumer inflation accelerated to 19.6%.

The cut “can be interpreted as a very strong message to market participants that the central bank intends to ease monetary policy regardless of negative consequences of the precipitous fall in the value of the lira,” said Piotr Matys, a senior currency analyst at InTouch Capital in London. 

“Today’s decision is an obvious disregard of warnings the market has already sent the CBRT that lowering rates -- when inflation is close to 20% and core inflation cannot be used as a valid argument to cut rates -- is a policy mistake,” Matys said, referring to the central bank by its English-language acronym. 

 “Further easing will depend on the lira’s performance, which local players will play a key role there as foreigners are pretty much out,” said Viktor Szabo, a fixed-income fund manager at Aberdeen Asset Management in London. “The risk of dollarization and more gold-buying has increased, locals need to hedge somehow against inflation,” he said.

Kavcioglu will update the bank’s base-case scenario for inflation through the rest of 2021 and the following two years on Oct. 28, and answer questions from economists and reporters. The central bank currently sees consumer-price growth finishing the year at 14.1%, a more optimistic forecast than the government’s latest estimate of 16.2%. 

The statistics agency will publish October inflation data on Nov. 3.

©2021 Bloomberg L.P.