Turkey's central bank raised its policy interest rate for the third time this year, and for the second time under its new governor, in what it said was a "strong monetary tightening" to eliminate the risks to the outlook for inflation and reiterated it would "decisively" maintain tight monetary policy until there is a permanent fall in inflation.
The Central Bank of the Republic of Turkey (CBRT) raised its one-week repo auction rate by another 200 basis points to 17 percent and has now raised it by 825 points following a first hike in September and then a second hike in November after the new governor, Naci Agbal, was installed by Turkey's strong-willed president, Tayyip Erdogan.
"Domestic demand conditions, cumulative cost effects, in particular the exchange rat effects, increasing international food and other commodity prices and deterioration in inflation expectations continue to affect the pricing behavior and inflation outlook adversely," CBRT's monetary policy committee (MPC) said, adding:
"Accordingly, the MPC, taking into account the end-2021 forecast target, has decided to implement a strong monetary tightening, in order to eliminate risks to the inflation outlook, contain inflation expectations and restore the disinflation process as soon as possible."
Agbal, the central bank's fourth governor in five years, took over from Murat Uysal who was fired by Erdogan on Nov. 6. Two days later, on Nov. 8, Berat Albayrak, Erdogan's son-in-law, resigned as finance minister, in another manifestation of the change in Turkey's economic leadership.
While CBRT was widely expected to continue tightening its monetary policy following last week's briefing by its governor, the hike was stronger than most economists had forecast. The average of polls had settled on a 150 basis point hike, within a range of 75 to 200 points.
The three rate hikes have more than erased the central bank's five rate cuts from January to May, with the one-week repo rate now 5 percentage points above its level at the start of the year and the highest since September 2019 when the central bank was in the midst of an easing campaign that began in July and continued through the COVID-19 crises at the start of the year until May when it stabilized for a few months at 8.25 percent before the shift in policy in September.
Despite the three rate hikes, Turkey's inflation rate has continued to accelerate and it jumped to 14.03 percent in November from 11.89 percent in October, almost three times the central bank's medium-term target of 5.0 percent.
But the rate hike was welcomed by the foreign exchange market with the lira continuing its recent rise from a record low around 8.52 to the U.S. dollar on Nov. 8 when Erdogan's son-in-law resigned.
Since then the lira has appreciated xx percent against the dollar to trade at 7.57 today 7.57 7.65
However, the lira is still down 21.4 percent since the start of the year, one of the biggest losers among emerging market currencies this year along with Argentina's peso, explaining some of the upward pressure on inflation from the rise in import prices.
The continued rise in the lira indicates that financial markets are still voicing confidence in the change in the direction of Turkey's economic policy following the change in finance minister and governor in November toward a more orthodox policy.
In addition to the change in governor and finance minister, Erdogan on Nov. 11 pledged a new economic strategy based on stability, lower inflation and international investment.
Erdogan's pledge came two days after the bank's new governor, Agbal, in his first public comments on Nov. 9 underscored his commitment to price stability.
On Dec. 16 Agal confirmed his determination to achieve disinflation, saying he would tighten policy to achieve this and a tight and decisive monetary policy would be maintained in 2021 to reach an interim target of 9.4 percent inflation by the end of 2021 and then 5.0 percent in 2023.
Agbal also confirmed that CBRT would be following a more normal monetary policy, with the one-week repo rate its main policy tool to signal its stance while the rate corridor and late liquidity window only used for temporary liquidity issues, unlike its move under the previous governor when markets were left confused as the bank on occasions used a range of tools to adjust lending rates.
Agbal's commitment to stamp out inflation and rebuild foreign exchange reserves - which have declined to a 15-year low - should also help in reducing the level of dollarization in Turkey where many citizens used U.S. dollars to protect their savings.
In recent years the central bank's policy has zig-zagged with investors questioning its commitment to low inflation - putting downward pressure on the lira - and its independence from political pressure as Erdogan for years has openly called for low interest rates to boost economic growth, arguing high interest rates cause high inflation, an view that is not shared by financial markets or economists.
In today's statement, the central bank confirmed that a tight monetary policy will be "decisively sustained until strong indicators point to a permanent fall in inflation in line with the targets and to price stability."
Turkey's economy has bounced back fast from the hit to activity in the second quarter, with gross domestic product rising 15.6 percent year-on-year in the third quarter after declining 10.8 percent in the second quarter.
CBRT said a partial recovery of the global economy is continuing in the fourth quarter though uncertainty prevails due to the recent rise in COVID-19 infections just as the vaccine is showing positive developments.
Nationally, data for the fourth quarter point to a "strong course" in economic activity but new restrictions due to the rising number of virus cases create uncertainty about the outlook in the short run, especially for the services sector.
