Turkey raises interest rates to 50% as it seeks to cool runaway inflation

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Turkey’s central bank surprised economists and investors on Thursday with a big rate rise as policymakers seek to cool runaway inflation and halt an accelerating capital flight among local savers.

The central bank increased its main interest rate 5 percentage points to 50 per cent. Most economists had expected it to hold rates steady ahead of local elections on March 31, according to a poll by Reuters.

Policymakers cited a “deterioration in the inflation outlook”, adding that the “tight monetary stance will be maintained until a significant and sustained decline in the underlying trend of monthly inflation is observed”.

The decision, which comes just weeks after governor Fatih Karahan indicated the central bank had probably ended its cycle of rate increases, highlights the extent to which Turkey’s economic situation has worsened this year despite a sweeping policy overhaul that kicked off in June.

The centrepiece of the new programme has been a reversal of the low-rate policies President Recep Tayyip Erdoğan had pursued for years and which had ignited runaway inflation. The central bank has increased rates 41.5 percentage points since Erdoğan’s re-election in May last year.

But other factors including a 49 per cent increase this year in the minimum wage, widely seen as a vote-winning measure ahead of this year’s elections, and rising costs of imported goods caused by a slumping lira have made it challenging for the central bank to get a grip on inflation.

Investors have broadly applauded the new economic programme, which has been credited with steering Turkey away from a potential balance of payments crisis or even the imposition of capital controls.

However, many remain worried about whether policymakers have moved fast or far enough to win the battle against inflation — prompting renewed concerns as some data worsened this year.

Consumer prices increased 4.5 per cent in February from January alone, bringing the annual growth rate to 67 per cent. The central bank predicts inflation will rise towards 80 per cent by the summer — close to its recent peak of 85.5 per cent in 2022 — before easing to 36 per cent by year end.

“The decision to respond so quickly to the recent strong inflation figures and hike rates before the local elections is clearly a very encouraging signal for the policy shift and should help to maintain investor confidence,” said Liam Peach at Capital Economics, who expects a further increase next month.

Turkey’s lira rose against the dollar after the decision, leaving the currency up 0.7 per cent to TL31.92 in London trading. The country’s dollar-denominated bonds also rose in price, while the cost to protect against a debt default fell.

Thursday’s rate rise will help to bridge a yawning gap between the rate of inflation and the interest rates that Turkish savers can earn from holding lira in their bank account, something that has sent them rushing to find alternatives, such as foreign currencies and stocks.

The total amount that Turkish residents are holding in foreign currency bank deposits has risen about $6bn this year to $128bn, according to the country’s banking watchdog. The lira has fallen 8 per cent against the dollar since the start of 2024 notwithstanding Thursday’s gains.

Savers have also been concerned that the central bank, which many economists believe has kept the lira’s losses steady in recent months, will allow it to fall more freely after the March 31 local elections.

The central bank’s foreign currency war chest, which had been refilled since the economic overhaul began last summer, has started dwindling again as savers have scrambled to purchase dollars and euros.

Net foreign assets, a key proxy for Turkey’s foreign currency reserves, fell to $7.2bn this week from $30.8bn in December, according to Financial Times calculations based on central bank data.

Hakan Kara, a former chief economist at the Turkish central bank, questioned why policymakers did not signal sooner that they planned to raise interest rates, since that would have staunched the reserve outflow. But he said the decision was a “welcome move” and “will definitely help to stop the erosion in the credibility of the central bank”.