Turkey Cuts Key Rate by 1% Despite Having 80% Inflation

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Turkey Cuts Key Rate by 1% Despite Having 80% Inflation

By Geoffrey Smith

Investing.com -- Turkey's central bank cut its key interest rate by a full percentage point on Thursday despite the country suffering 80% inflation .

In a statement accompanying the decisions, the bank justified its action by pointing to an expected growth slowdown in the current quarter and expectations that a process of disinflation will soon set in after a surge in prices in the spring triggered by Russia's invasion of Ukraine.

The bank cut its one-week repo rate to 13% from 14%, after holding it steady for the past year. It also cut its overnight deposit and lending rates, which form a corridor for short-term lira market rates, by a similar amount to 11.50% and 14.50% respectively.

The announcement hit the lira , which has been badly undermined by a decade of unorthodox and often erratic macroeconomic policies under President Recep Tayyip Erdoğan. The dollar spiked as high as 18.1488 against it before paring its gains to be up 0.7% at 18.0759 by 08:00 ET (12:00 GMT). The benchmark BIST 100 stock index fell sharply before recovering to trade roughly where it was before the announcement. Credit default swaps on the country's sovereign bonds, meanwhile, widened by around 50 basis points.

The lira is already down some 27% against the dollar so far this year against the backdrop of runaway inflation that the central bank has been unable to tackle effectively. The consumer price index was up 79.6% in the 12 months through July, setting the stage for what would be a second currency crisis in only four years. Erdoğan fired his last central bank governor for failing to accommodate his economic stimulus policies by keeping interest rates too high as the effects of the 2018 currency crisis eased.

In its statement, the CBRT said it expects a "disinflation process to start on the back of measures taken and decisively implemented for strengthening sustainable price and financial stability, along with the resolution of the ongoing regional conflict," in what appeared to be a nod to Erdoğan's role in helping the UN to broker a deal allowing Ukraine's grain exports to reach world markets. The conflict between Russia and Ukraine continues, but that deal has helped allay fears of food shortages in many poor countries that are dependent on Ukraine and Russia for wheat imports. U.S. Wheat Futures are now below their levels immediately before the invasion in February.

That, along with the global drop in energy prices since the middle of the year, has taken some of the steam out of Turkish inflation, which ran at a monthly rate of 'only' 2.37% in July, down from a peak of 13.6% in January and its smallest increase since October last year.

Even so, analysts were baffled by the decision.

"Just when you think the CBRT cannot get any crazier, they go to yet another level of craziness," said Tim Ash, an associate fellow at Chatham House in London.

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