Turkey lifts interest rates for second consecutive month in effort to tame inflation

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Turkey’s central bank has boosted borrowing costs for the second time in as many months as the country intensifies its battle against inflation and gradually unwinds its low-rate policy that tipped its economy into crisis.

Policymakers raised the one-week repo rate by 2.5 percentage points to 17.5 per cent. Local businesses were anticipating an increase to 20 per cent, according to a poll by the central bank before Thursday’s decision.

The interest rate rise marks the latest sign of how Turkey is overhauling its economic policies after President Recep Tayyip Erdoğan was re-elected in May. New finance minister Mehmet Şimşek has vowed to restore “rational” policies after years of unorthodox measures pursued by Erdoğan, including an insistence on keeping rates low, fuelled runaway inflation and a huge trade deficit.

“The committee decided to continue the monetary tightening process in order to establish the disinflation course as soon as possible, to anchor inflation expectations and to control the deterioration in pricing behaviour,” the central bank said on Thursday.

Hafize Gaye Erkan, a former Wall Street banker, was tapped in June to lead the central bank. The central bank soon increased rates from 8.5 per cent to 15 per cent and pledged the “monetary tightening process will continue until a significant improvement in the inflation outlook is achieved”.

Some analysts worry that Erdoğan, a life-long opponent of high interest rates, will not let the central bank increase rates high enough to tame inflation, particularly with important local elections looming early next year. Some members of Erdoğan’s ruling Justice and Development party have also criticised the new economic policy.

Turkey has taken a series of other steps in recent weeks aimed at cooling domestic demand and re-refilling government coffers that have been depleted by huge pre-election giveaways and a huge effort to rebuild the vast area of the country’s south that was ravaged by February’s earthquake. The government recently tripled petrol taxes following an increase in value added taxes on a broad swath of goods and services.

Ankara has also backed away from its defence of the lira, which seriously depleted Turkey’s foreign currency reserves. The currency has tumbled more than a fifth against the dollar since the start of June to a record low of TL27 as a result.

Economists say that the weak lira, which makes imports more expensive, and the tax rises will trigger a fresh bout of inflation. Local business executives expect inflation to rise from about 38 per cent in June to 45 per cent by the end of this year, according to the central bank poll. Bank of America said this week it expects inflation to reach 65 per cent by May 2024.

Still, there are early indications that the new policies are beginning to bear fruit. Turkey’s foreign currency reserves have jumped $14bn since the end of May, while foreign investors, who have largely abandoned Turkish financial assets in recent years, have pumped $1.3bn into the equity market in the five weeks to July 7.

Saudi Arabia and the United Arab Emirates also this week pledged to make fresh investments in Turkey as Erdoğan embarked on a tour of the Gulf region. ADQ, one of Abu Dhabi’s state investment funds, also said it would provide up to $8.5bn through bonds to support reconstruction efforts after the earthquake.