Turkey's Central Bank stuns markets with strong rate cut amid soaring inflation

Turkey’s Central Bank shocked investors on Thursday by cutting its official interest rate by 200 basis points from 18 percent to 16 percent under pressure from President Recep Tayyip Erdogan.

The bank’s announcement quickly dealt a blow to an already struggling Turkish lira, which posted another record-breaking loss, depreciating by more than two percent to 9.48 lira per US dollar.

The bank, in a written statement, said that it believes soaring inflation, 19.58 percent last month, is driven by side factors such as food and import prices, especially in energy. The bank said that these were transitory factors because of post-Covid economic growth in the country.

The bank’s decision has put Turkey’s policy interest rate two percent below the official inflation rate, pushing investors to short the lira and invest in other monetary tools. 

The Turkish lira has already lost more than 20 percent of its value against the dollar since the beginning of this year. 

However, one crucial indicator by the bank was that it lost its appetite to further rate cuts this year. “The Monetary 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 statement said.

Governor Sahap Kavcioglu has been under fire since he has taken the helm of the bank last March after a campaign by pro-government media that blamed the previous governor, Naci Agbal, as an incompetent bureaucrat who works in the hands of the “interest lobby”.

The leader of the Turkish opposition, Kemal Kilicdaroglu from the Republican People's Party (CHP), visited Kavcioglu and the bank last week to pressure the bank to not cut interest rates. He also said on Thursday that he was waiting for the bank to do the right thing. 

President Erdogan has fired several governors in recent years because of their resistance to cut policy rates to his liking.

Sources speculated earlier this month that Erdogan was also frustrated by Kavcioglu’s slow progress in cutting interest rates and he could be fired soon.

The Turkish presidency quickly dismissed the speculation, and then Erdogan fired three members of the monetary committee that were known for their stance against the interest rate cuts.

Erik Meyersson, a professor of economics formerly of Goldman Sachs, said that Thursday's rate cut has already dramatically affected the markets. “Lira depreciating rapidly, sovereign bonds 10 year yields is 20.4%, and 5y5y breakevens are now just under 17%(!), worse than just after [former central bank chief Naci] Agbal's dismissal,” he tweeted.

Ugur Gurses, a well-known financial columnist in Turkey added: "Those who take the statements of the Central Bank monetary committee seriously, and look for a rational aspect there, will wake up in shock."