Turkey Poised for 5th Consecutive Rate Hike as Inflation Pressures Mount

Turkey is set to raise its benchmark interest rate for the fifth consecutive time on Thursday as the country grapples with rising inflation, which is anticipated to approach 70% by the end of the year.

The Monetary Policy Committee of the central bank is expected to announce a 500 basis point increase in the benchmark rate, bringing it to 35%. This projection aligns with the consensus among most analysts surveyed by Bloomberg, including prominent institutions such as Goldman Sachs Group Inc. and Morgan Stanley.

The central bank of Turkey has embarked on a series of aggressive interest rate hikes since President Recep Tayyip Erdogan’s re-election in May. This monetary policy tightening is part of the government’s efforts to reverse years of unconventional economic measures, which were criticized for deterring foreign investors and contributing to a series of currency crises. Under the stewardship of Governor Hafize Gaye Erkan, who assumed her role in June, the central bank has already increased rates by nearly 22 percentage points.

However, despite these substantial rate hikes, real (inflation-adjusted) interest rates in Turkey remain deeply negative. Many financial market experts argue that the country has not acted aggressively enough and needs to implement even swifter measures to attract more foreign investment into its bond markets.

Some policymakers, including Finance Minister Mehmet Simsek, have urged investors to consider deposit rates relative to projected inflation. Currently, average deposits of up to three months offer returns of nearly 45%, while the central bank predicts a deceleration of annual price growth to 33% by the end of 2024.

“This monetary policy is more stringent than what the headline rate suggests,” noted Simsek. He also emphasized the implementation of regulatory measures to curb credit growth.

The impending rate hike on Thursday could be one of the last before Turkey holds local elections in March. President Erdogan, a long-time advocate of low interest rates, is striving to regain control of opposition-held cities like Istanbul and Ankara. As the election date approaches, he may be reluctant to further tighten the country’s monetary policy.

Nonetheless, the recent outbreak of conflict between Israel and Hamas could exacerbate inflationary pressures for major energy importers like Turkey. This situation might prompt the Turkish central bank to advance some rate hikes that were initially planned after the elections, according to Deutsche Bank AG.

Deutsche Bank economists, including Yigit Onay, forecast that Turkey will increase its one-week repo rate to 40% by the end of 2023 due to “heightened geopolitical risks and their potential impact on Turkey’s inflation and balance of payments.”

Morgan Stanley economists Hande Kucuk and Alina Slyusarchuk also anticipate a rate peak at 40%, but not until April.

On the other hand, some financial experts hold more pessimistic views. Tepav, an Ankara-based think tank that includes former central bankers, is skeptical that the Monetary Policy Committee can achieve the forecasted 33% inflation rate by the end of next year without raising the policy rate to “at least” 40% this month.

Governor Hafize Gaye Erkan is scheduled to present her final inflation report for the year on November 2, during which she will also field questions from journalists and economists. The minutes from last month’s policy meeting indicated that worsening pricing behaviour in recent months could push year-end inflation closer to the upper bound of the central bank’s forecasts, potentially reaching 62%.

Nevertheless, some economists are anticipating a less hawkish stance from the central bank this week. HSBC Holdings Plc and Barclays Plc are among those who expect a rate increase of just 250 basis points. “For now, we do not anticipate additional rate hikes for the fourth quarter of 2024,” stated HSBC economist Melis Metiner, based in London. Nevertheless, she acknowledged that “if disinflation continues to disappoint, the central bank may find itself needing to take more aggressive actions.”