Turkey's central bank held its benchmark one-week repurchase rate steady at 4.5 percent but raised its overnight lending rate by a sharp 75 basis points and said it would tighten monetary policy further if necessary to support financial stability.
The Central Bank of the Republic of Turkey (CBRT), which has been battling to stem the fall in its lira currency, said recent developments had an adverse affect on inflation, including a surge in unprocessed food prices, rising oil prices and the increased exchange rate volatility may continue to adversely impact inflation in the short term.
"Although the Committee sees these developments as temporary to a large extent, a measured tightening is deemed necessary in order to contain a deterioration in the pricing behaviour," the central bank said after a meeting of its monetary policy committee.
"A cautious stance will be maintained until the inflation outlook is in line with the medium term targets. In this respect, additional monetary tightening will be implemented when necessary," it added.
Turkey's central bank uses its interest corridor to fine tune its monetary policy stance and while it maintained the overnight borrowing rate at 3.5 percent, the overnight lending rate was raised to 7.25 percent from 6.5 percent. The rate on its borrowing facility for primary dealers via repo transactions was raised to 6.75 percent from 6.0 percent.
Turkey's inflation rate jumped to 8.3 percent in June from 6.51 percent in May, the highest rate in 10 months, and well above the central bank's 5.0 percent target for this year and 2014.
The move by the central bank was widely expected following a statement last week by the bank's governor, Erdem Basci, that said "a measured step to widen the interest rate corridor" would be on the agenda for the committee's meeting today.
The CBRT also said it would increase the flexibility of its liquidity management through the composition of lira provided to banks "due to the ongoing uncertainties regarding the global economy and the volatility in capital flows."
Like many other emerging market currencies, Turkey's lira has been under pressure since early May from an expected reduction in asset purchases by the U.S. Federal Reserve, along with concern by international investors over domestic political unrest.
The central bank has intervened in foreign exchange markets, spending a reported $6.6 billion of its reserves to shore up the lira. While the lira tumbled almost 9 percent from early May through early July, it then start to bounce back after intervention, and is down 6.7 percent from the start of this year. Today the lira was quoted at 1.91 to the U.S. dollar compared with 1.78 in early January.
"Capital flows have weakened since May due to increasing uncertainty regarding the global monetary policies," the central bank said, adding that loan growth was above the reference rate and the tightening in policy would help support financial stability.
Turkey's economy is developing in line with the central bank's expectations, with domestic demand still recovering at a healthy pace and exports growing moderately and the current account deficit stable, the central bank said.
Turkey's Gross Domestic Product rose by 1.6 percent in the first quarter from the previous quarter for annual growth of 3.0 percent, up from 1.4 percent in the fourth quarter.
The central bank has cut its benchmark repo rate twice this year, most recently in May by 50 basis points to 4.5 percent when it also shifted the interest rate corridor down, with its policy in recent years aimed at controlling an excessive inflow of capital that put upward pressure on its lira.