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Turkey: Markets in shock as central bank cuts interest rate despite soaring inflation

Lira lost one percent of its value against the dollar after the announcement of the cut in the rate from 14 to 13 percent
A sharp depreciation in the value of the lira has eroded living standards and pushed the Turkish financial sector to the brink of crisis (Reuters)

Turkey's central bank on Thursday stunned the markets by lowering its main interest rate even as inflation soared to a 24-year high and looks set to climb further.

The central bank said "recession is increasingly assessed as an inevitable risk factor" as it lowered its one-week repo auction rate to 13 percent from 14 percent.

"Just insane - with inflation at 80 percent and rising," BlueBay Asset Management economist Timothy Ash remarked in an emailed comment to AFP. "I don't think anyone expected this."

The Turkish lira lost one percent of its value against the dollar within moments of the announcement, AFP reported.

'I don't think anyone expected this'

- Timothy Ash, BlueBay Asset Management economist 

Turkey's monetary policy decision contradicts the approach pursued by most other countries as they try to combat the spike in consumer prices caused by global supply chain issues and Russia's invasion of Ukraine.

The war has sent food and energy prices soaring and forced central banks to raise borrowing costs - even as economic growth remains anaemic. 

Turkish President Recep Tayyip Erdogan subscribes to the unorthodox belief that high interest rates cause inflation rather than rein it in.

He has fired three central bank governors since 2019 who have tried to pursue a more conventional economic policy.

Election focus

Turkey now has a negative real interest rate of 66.6 percent when adjusted for inflation.

The situation forces businesses and ordinary people to spend as much as possible before their liras lose even more value with each month.

Turkey's unorthodox approach has propelled the economic growth that Erdogan hopes can help him secure a third decade in power in a general election scheduled for next June.

But it has been accompanied by a sharp depreciation of the lira that has eroded living standards and pushed the financial sector to the brink of crisis.

The Turkish government has adopted a series of alternative measures to combat inflation which most economists dismiss as either insufficient or too complex and expensive to work.

These include limiting bank lending and offering state guarantees to ensure that Turks' deposits do not lose too much value over time.

Foreign currency reserves

Turkey has also dug deeply into its foreign currency reserves to try and prop up the lira's exchange rate.

These interventions have made Turkey increasingly dependent on deals with petrodollar-rich nations such as Russia and Ankara's one-time rivals in the Middle East.

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Turkey reported a big jump in its hard currency holdings this month that the finance minister linked to a money transfer from an unnamed foreign country.

Last month, Middle East Eye reported that Russia's state-held nuclear energy firm Rosatom had sought a $6.1bn loan deal to fund the construction and development of Turkey's Akkuyu nuclear power plant, including plans to deposit some of the money with the Turkish Ministry of Treasury and Finance. 

The central bank vowed on Thursday to push ahead with its "liraisation strategy" aimed at reducing the use of foreign currency.

It also spelled out its sharp focus on economic growth.

"It is important that financial conditions remain supportive to preserve the growth momentum in industrial production and the positive trend in employment," it said.