Lira Rallies as Turkey Stuns With Biggest Rate Hike in Years

Turkey raised interest rates far more than investors expected, triggering a rally in the lira, in the latest sign that a new lineup of central bankers favors aggressive moves to curb inflation running near 50%.

(Bloomberg) — Turkey raised interest rates far more than investors expected, triggering a rally in the lira, in the latest sign that a new lineup of central bankers favors aggressive moves to curb inflation running near 50%.

The lira reversed losses after the decision and then extended its rally, appreciating as much as 7% against the US dollar. The currency was trading at 25.48 per greenback as of 3:52 p.m. Istanbul.

The Monetary Policy Committee, under Governor Hafize Gaye Erkan, raised the benchmark one-week repo rate to 25% from 17.5%, the sharpest increase since 2018. Most economists polled by Bloomberg predicted a hike to 20%.

It’s the latest indication that Turkey’s new administration is prepared to move away from the unorthodox policies — including ultra-low borrowing costs — that were championed by President Recep Tayyip Erdogan but caused foreign traders to flee the country’s bond and stock markets en masse. 

Since winning reelection in May to take his rule into a third decade, Erdogan has pledged to shift course to rein in inflation and get investors back.

Markets cheered the rate announcement on Thursday. Bank shares surged and the cost to insure Turkish debt against default for five years dropped below 400 basis points.

The one week-repo rate is now at the highest since Turkey started to use it as the sole benchmark. Official borrowing costs were last above 25% in 2004, when the central bank used the overnight borrowing and lending rates to conduct monetary policy.

It was the MPC’s first decision since three new deputy governors were appointed late last month. They included a former adviser to the Federal Reserve Bank of New York and the ex-chief economist at one of Turkey’s biggest private lenders.

Piotr Matys, a currency analyst at InTouch Capital Markets in London, said the decision “sends a very strong signal that the central bank is determined to rein in inflation.”

What Bloomberg Economics Says… 

“Turkey’s central bank has stunned by agreeing a supersized rate hike that we see as a front-loaded move aimed at carrying a strong message of a change of policy from the newly installed MPC members. Looking ahead, we expect the central bank’s policy actions to be focused on further revisions and undoing in its complex set of regulations and practices.”

— Selva Bahar Baziki, economist. Click here to read more.

The MPC said it “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 behavior.”

Read more: Ex-NY Fed Economist Among Three Central Bankers Named by Erdogan

Erkan, appointed in June, is bringing to an end an era of ultra-loose monetary policy. The governor has said annual price growth won’t peak until the second quarter of next year at about 60%. 

Apart from raising policy rates, the central bank has also taken other measures to increase the cost of money. Its latest regulation took aim at a government-backed savings program that protects account holders from any weakening of the lira. Officials now want them to convert to normal lira accounts.

On Thursday, the MPC said that the recent regulations would “strengthen the monetary-transmission mechanism” and the committee would continue “to make decisions on quantitative tightening and selective credit tightening.”

While Erkan has now brought rates to nearly triple their level when she took over in June, critics continue to question her commitment to tighter policy after two previous decisions underwhelmed traders’ expectations.

Turkey’s inflation-adjusted rates remain well in negative territory and among the lowest in the world.

“It’s really hard for me to get excited about this hawkish surprise after two straight dovish surprises,” said Win Thin, global head of currency strategy at Brown Brothers Harriman in New York. “Let’s talk after the next decision September 21 and if it delivers another large hike, perhaps things really have changed.”

–With assistance from Joel Rinneby and Tugce Ozsoy.

(Updates with markets in second paragraph.)

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