Turkey surprises with interest rate cut as inflation soars

President Recep Tayyip Erdoğan has an unusual theory that high interest rates cause inflation. Photo / Khalil Hamra, AP

Turkey has shocked markets with a 100 basis point interest rate cut despite inflation of nearly 80 per cent, as the central bank loosens policy further to spur growth ahead of a general election next year.

The bank had been expected to keep the rate at 14 per cent, which has already pushed real Turkish yields into deeply negative territory, according to a poll by broadcaster Bloomberg HT. Instead, policymakers lowered the rate to 13 per cent, saying they were concerned about the possibility of slowing economic growth.

"Leading indicators for the third quarter point to some loss of momentum in economic activity," the bank said in a statement on Thursday.

"It is important that financial conditions remain supportive to preserve the growth momentum in industrial production, and the positive trend in employment in a period of increasing uncertainties regarding global growth as well as escalating geopolitical risk."

The lira dropped about 1 per cent to as low as 18.14 against the US dollar, the weakest level on an intraday basis since a severe slide late last year.

The currency has tumbled more than 25 per cent in 2022 as scorching inflation and deep concern over the central bank's unorthodox monetary policy have prompted foreign investors to flee the market.

Turkey has been bucking the trend of other central banks that are raising borrowing costs to rein in global inflation.

Şahap Kavcioğlu, the central bank governor, supports president Recep Tayyip Erdoğan's unusual theory that high interest rates cause inflation, while mainstream economists subscribe to the opposite view.

"Instructions may have come down for a cut amid signs growth may be slowing," said Ceyhun Elgin, a professor of economics at Boğaziçi University in Istanbul. "The aim may be to carry things forward, for better or for worse, until the election."

Erdoğan's ruling party has seen its support tumble to historical lows amid widespread unhappiness with the cost of living in Turkey, less than a year before elections. The president is betting that the weak lira will help manufacturers export more goods and cheap credit will boost investment and jobs.

Kavcioğlu, who took the helm at the bank last year, began easing monetary policy in September, cutting rates from 19 per cent. That has unleashed Turkey's highest inflation in a quarter century. Rates, until Thursday, had been unchanged at 14 per cent since December.

In recent weeks, the central bank has recorded a sharp rise in its foreign currency reserves, helped by inflows from governments abroad, according to the finance minister.

This may have encouraged Kavcioğlu to cut rates again, giving the bank more of a buffer if it has to intervene to support the lira, Elgin said. But the bank's coffers remain about $61bn in the red, when liabilities to other banks are accounted for, according to Goldman Sachs estimates.

"With this decision, the central bank of Turkey drops any residual pretence to be targeting inflation and reveals its overarching goal of supporting growth. With inflation at 80 per cent, however, this recipe only spells disaster," Cristian Maggio, head of emerging markets strategy at TD Securities, wrote in a note.

The central bank officially targets inflation of 5 per cent by the end of 2022.

-By Ayla Jean Yackley in Istanbul