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Turkey’s lira bounces as central bank finally raises interest rates to battle inflation

Key Points
  • Turkey's lira made gains on Wednesday after its central bank raised interest rates for the first time this year in an effort to counter the country's ballooning inflation.
  • Central bank interest rates have been kept low to fuel GDP growth in the country of nearly 80 million, subsequently bringing inflation to 10.2 percent.
  • The hike of 75 basis points brought rates to 13.5 percent and saw the lira strengthen by 1 percent to 4.0475 on the dollar Wednesday afternoon.
People walk past a sign offering customers a 10TL gift if they exchange more than $1,000 or euro at a currency exchange store on December 5, 2016, in Istanbul.
Chris McGrath | Getty Images

Turkey's lira made gains on Wednesday after the country's central bank raised interest rates for the first time this year in an effort to counter ballooning inflation.

In a policy directed by Turkish President Recep Erdogan, central bank interest rates had been kept low to fuel gross domestic product (GDP) growth in the country of nearly 80 million, which led the G-20 at 7.4 percent in 2017.

But prioritizing growth to this extent has come at the expense of inflation, which currently sits at a lofty 10.2 percent.

Erdogan has aggressively pushed his controversial policy, openly calling himself an "enemy of interest rates" and long keeping the Central Bank of the Republic of Turkey's (TCMB) hands tied, according to some analysts.

Markets were relieved at the central bank's decision Wednesday, which hiked its rate by 75 basis points to 13.5 percent. Subsequently, the lira — billed as one of the worst emerging market currencies so far this year — strengthened by 1 percent to 4.0475 on the dollar on Wednesday afternoon. The previous week saw it hit an all-time low of 4.1944 against the dollar; it had depreciated 13.9 percent since August.

The TCMB announced that it would continue to tighten policy as needed. Speaking at the International Monetary Fund (IMF) meetings this month, Turkish Deputy Prime Minister Mehmet Simsek described bringing inflation down to the single-digits as a government priority.

"The market was primed for a sell-off if the (central bank) had failed to hike," said Timothy Ash, senior emerging markets strategist at Bluebay Asset Management, who described the bank's decision as doing the "right thing" in a difficult political setting.

Playing into the elections

In what was widely viewed as a power grab, Erdogan announced early elections last week, something that very likely played into this policy move. Presidential and parliamentary elections slated for November 2019 will now be held in June of this year, with the turbulent economy seen as the main reason for the frantic switch.

Turkish President Recep Tayyip Erdogan speaks during a press conference at the Presidential Complex in Ankara, Turkey on April 18, 2018.
Ali Balikci | Anadolu Agency | Getty Images

A win would allow Erdogan to mitigate the fallout of a worsening economy on his popularity. It would also enable him to to eliminate the position of prime minister and weaken parliament, thanks to a constitutional referendum passed last year that would heavily concentrate the president's power.

"If anything, this was more about anchoring the exchange rate this side of elections rather than showing steel in the fight against inflation," said Bluebay's Ash, adding that Turkish consumer confidence and likely electoral preferences will be driven by the stability of the lira from very depreciated levels.

"If the CBRT can keep the exchange rate stable then this certainly plays to Erdogan in the election as, in the end, this election is significantly about the economy," Ash said.

The rate hike, he added, is a reflection of the "difficult challenges" the Turkish economy is now facing, amid deepening concerns over a growing current account deficit, sticky inflation and the consequent squeeze on consumers.