Turkey's central bank jacked up the country's key interest rate Thursday, almost doubling it from 8.5% to 15% as the new economic administration of recently reelected President Recep Tayyip Erdogan embarked on a dramatic monetary policy U-turn.
The bank said there will be further gradual monetary tightening until the inflation picture in the country improves.
The whopping 650 basis point rate rise is the country's first since March 2021, but was below analyst expectations of a 1,150 basis point hike to 20%.
"The Committee decided to begin 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," the central bank, led by newly appointed Governor Hafize Gaye Erkan, said in a statement.
Some analysts criticized the central bank's move as not going far enough, however.
"Ouch — disappointing. Not enough," Timothy Ash, an emerging markets strategist at BlueBay Asset Management, wrote in an note via email. "They needed to front load hikes. Market won't like that."
The Turkish lira weakened to around 24.1 against the dollar following the news, from 23.54 before the decision was announced — a record low, according to Reuters data.
George Dyson, a senior analyst at the consultancy Control Risks, believes there will be further hikes in order to bring the policy rate up to 20% or higher.
Turkish Finance Minister Mehmet Simsek "has to be a little cautious," he told CNBC. "I'm confident he is worried about inadvertantly triggering a debt crisis by slowing the economy too fast."
Hamish Kinnear, a senior Middle East and North Africa analyst at risk intelligence firm Verisk Maplecroft, agreed.
"This is a sign that the new governor is looking to tread carefully to avoid a clash with President Erdogan – the last central bank governor to hike interest rates was fired by the president after less than five months in the post," Kinnear said.
U-turn
Turkey steadily lowered its policy rate from 19% in late 2021 to 8.5% in March as inflation ballooned, breaching 80% in late 2022 and easing to just under 40% in May. Traditional economic orthodoxy holds that rates must be raised to cool inflation, but Erdogan, a self-declared "enemy" of interest rates who calls the tool "the mother of all evil," vocally espoused a strategy of lowering rates instead.
The result was a cost-of-living crisis for Turks as the country's currency, the lira, plummeted. It's lost some 80% of its value against the dollar in the last five years, and Turkey has found itself precariously low on foreign currency reserves as it sold billions of dollars in foreign exchange to prop up the lira.
The architect of Turkey's attempted return to economic orthodoxy is Simsek, the Erdogan-appointed finance minister who previously served as deputy prime minister and finance minister between 2009 and 2018, and is widely respected by investors. After several years of Erdogan exerting heavy control over Turkey's central bank, the president appears willing to let the monetary policymakers have more independence — at least for now.
"Erdogan has accepted that short-term pain is necessary to redress the economy, and that appearing to empower Simsek will play well with markets," Dyson said.
"The question will be how long Erdogan will tolerate that pain for, and if and when societal pressure get too much and he wrests back control from Simsek," he said. "The temptation will be ever present for Erdogan to intervene once again."
In mid-June, Erdogan said his opposition to raising rates was unchanged, but said he would abide by Simsek's decisions in order to bring down inflation.
"Some of our friends should not be mistaken, such as (asking), 'Is our president going for a serious change in interest rate policies?'" he told reporters at the time. "But upon the thinking of our treasury and finance minister," Erdogan added, "we have accepted that he will take steps swiftly, comfortably with the central bank."
'A lot of macroeconomic vulnerabilities'
A number of policy changes will be necessary to bring Turkey's economy back on track. In addition to the lira sitting at its weakest ever level against the dollar, Turkey's current account deficit has widened more than market expectations in recent months and official reserves have been drawn down, declining by more than $8 billion in April alone.
"Turkey is currently enduring a lot of macroeconomic vulnerabilities thanks to the low interest rate policy that has been implemented since Sept. 2021, and obviously high inflation," Can Selcuki, director at Istanbul-based polling data firm Turkiye Raporu, told CNBC.
"So this is an attempt to take the country back to a orthodox monetary policy and reduce inflation in the meantime, and get some space to start fixing the macroeconomic problems and roll back some of the policy that has been implemented in the lead-up to the election."
While many analysts have expressed confidence in the dedication of Turkey's new monetary policymakers to raise rates and cool inflation, some note that ultimately, Erdogan's level of authority over his government means if he wants to abruptly reverse course, he can.
"If the likely impacts of orthodox policies, such as slowing economic growth from interest rate hikes, appear to threaten the president's popularity he could perform a volte face and fire the new central bank governor," Verisk Maplecroft's Kinnear said. "There are no meaningful checks on Erdogan's power that would prevent him from doing so."