The Turkish central bank kept its main policy rate unchanged at 19% at its May meeting. The bank had not been expected to change rates given high inflation on one hand but the governor’s loyalty to President Recep Tayyip Erdoǧan on the other. Monolith continues to expect the rate to be cut as soon as inflation shows signs of relenting, with significant reductions still anticipated by the end of this year.
The Monetary Policy Committee of the Central Bank of the Republic of Turkey (CBRT) kept its main policy rate, the one-week repo rate, steady at 19.0% at its scheduled 6 May rate-setting meeting. The other major policy rates – the late liquidity policy rate and the overnight rates – also remained unchanged.
The CBRT raised the repo rate three times between November 2020 and February 2021 by a total of 875 basis points. The last increase contributed to the ouster of then CBRT governor Naci Aǧbal, to be replaced with current governor Şahap Kavcioǧlu. The current governor is closely aligned with President Erdoǧan’s economic policies, which are vehemently opposed to elevated interest rates.
In its press release alongside the meeting, the CBRT cited both demand and cost factors, along with high expectations, as the causes for sustained, high inflation. The bank has pledged to keep the policy rate above the prevailing rate of inflation, which in April continued to accelerate.
Outlook
The initial market reaction to the rate decision was sanguine, with the Lira actually rallying faintly. Expectations that the policy rate would be unmoved were widespread.
Despite the acceleration of inflation in April, a rate rise was universally discounted given Kavcioǧlu’s loyalty to Erdoǧan. Moreover, the central bank under Kavcioǧlu has conspicuously dropped pledges made under Aǧbal to further tighten monetary policy if needed.
On the other hand, the continued acceleration of inflation ensured that any premature rate cut in May would have unleashed a strong, negative market reaction, including a sharp Lira depreciation. Thus, few observers had expected the CBRT to move this soon to cut rates.
Given the known proclivity of Kavcioǧlu towards lower interest rates, we continue to assume that current policy rates will be rolled back as soon as a modicum of success is achieved in arresting the acceleration of inflation. Base effects and the stabilization of the Lira in recent weeks suggest that April may have been the peak of the current acceleration of inflation. However, we forecast that annual inflation will remain above 17% until the fourth quarter.
Even with continued high inflation, the stemming of further acceleration may provide grounds for the CBRT to at least make a modest cut during the third quarter. By the fourth quarter, we anticipate that the policy rate will be cut more aggressively, likely triggering a greater depreciation of the Lira over the final months of the year and slowing any progress in further taming inflation.
Given elevated inflation, the interest rate may not be driven back down to single digits as we had initially anticipated when Kavcioǧlu was first appointed. We still expect that the policy rate could be cut by up to 400 basis points by the end of this year.