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Turkey central bank still beholden to politics?

What's going on with Turkey's central bank?

Turkey's central bank left interest rates steady on Tuesday, with analysts expressing concern that political pressure may prevent the bank from delivering an inflation-fighting rate hike in coming months.

The central bank kept its benchmark one-week repo rate at 7.5 percent for a fourth straight month, in line with expectations.

It comes at an interesting time for the country, with analysts – who think a rate hike is needed to counter rising prices – disagreeing with the government, which has piled on pressure for a rate cut to boost growth. The central bank cut rates earlier this year amid political pressure.

Analysts said they doubted that a weakening in the ruling AKP party's grip on power following elections earlier this month would see the government ease up on its demands for cuts.

In fact, Turkey's Economy Minister Nihat Zeybekci on Monday renewed his call for lower rates.

Turkish President Recep Tayyip Erdogan
Murat Cetinmuhurdar | Anadolu Agency | Getty Images

"It's been very off putting in the past few years, we've seen a complex monetary policy system that has prevented the central bank from raising interest rates when it should have done, which has caused it to lose credibility in the markets," William Jackson, senior emerging markets economist at Capital Economics, said on CNBC ahead of the rate decision.

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"Some of the pressure may have diminished with no party gaining a majority in the election, but I think it will still prevent them from raising rates today."

Turkey's AK failed to win a parliamentary majority for the first time since coming to power more than a decade ago. The party, founded by President Tayyip Erdogan, now needs to find a partner to form a coalition government.

Erdogan had repeatedly called for sharp rate cuts in the run-up to the June 7 parliamentary election, denouncing those who defended high interest rates as "traitors."

Is Turkey's risk of a rate hike rising?

Credibility issue

Inflation in Turkey is running at just above 8 percent, higher than the 5-percent official target. Price pressures are likely to be fueled by weakness in the Turkish lira, which fell to a record low against the dollar earlier this month, analysts said.

"While there is an argument that the weaker standing of the AKP gives the central bank a freer hand to hike rates, it's a very tenuous one to say the least," Nicholas Spiro, managing director at Spiro Sovereign Strategy, told CNBC.

"The central bank's inflation-fighting credibility was damaged long before political pressure started to build," he added. "Look at the gap between Turkey's inflation rate and the target and you can see what a poor track record the central bank has had. It should be hiking rates, maybe not aggressively, but definitely tightening policy further."

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Some analysts, however, argued that the change in the political landscape could be positive for Turkey's central bank.

"I think the situation has changed in Turkey after the elections, since the political landscape has changed," Salman Ahmed, global and EM fixed Income strategist at Lombard Odier, told CNBC earlier on Tuesday.

"I would argue, contrary to the consensus, that given the seismic shift in the political situation, the central bank's hand has been strengthened and he (Governor Erdem Başçı) can run a more independent central bank going forward."