Turkey’s central bank raised interest rates from 15 to 17.5 percent. This is the second increase since Recep Erdogan won the presidential election in May, and the second disappointment
Monetary authorities remained indifferent to the lira’s new weakness. The USD/TRY exchange rate, breaking 27.00 in the past days, not only reached the highest levels in history, but also found itself 35 percent. above the levels two months ago.
The reshuffle in the power camp was intended to rebuild investor confidence destroyed by twenty years of unorthodox politics and introduce Turkey to the path of market reforms. The June move, the first in over two years, was widely perceived as a disappointment. Raising the interest rate from 8.5 to 15 percent by the monetary authorities, headed by Hafize Erkan. meant that the bet was placed on a gradual abandonment of an extremely accommodating monetary policy, which was incompatible with inflation of several dozen percent. The scale of today’s move is also smaller than most market forecasts. This fuels doubts as to whether the change in course of the Turkish authorities will be enough to tame the gigantic internal and external imbalances, and raises speculations that the Turkish president is hindering reforms from the backseat.
The verdict of the markets is clear. Only shock therapy gives a shadow of a chance to rebuild trust lost over two decades of unconventional politics and to control inflation of several dozen percent. Although the CPI dynamics slowed down to 38.2% in June. y/y, but it was the last month of slowing down price growth in the near future.
A combination of generous pay increases, including 34 percent a jump in the minimum wage, and a sharp post-election sell-off of the Turkish currency, heralds that inflation could return to 50% before the end of the year. y/y In the short term, tax increases are also important, which are intended to improve the deteriorating condition of public finances. In recent days, changes have been announced, the aftermath of which is estimated at 20 percent. increase in fuel prices. And yet, in conditions of deep, entrenched macroeconomic imbalances, inflation expectations of households are particularly difficult to control.
Inflation is not Turkey’s only problem. The improvement in the situation in the balance of payments will probably prove to be temporary and will lose momentum towards the end of the year, and the current account deficit, although it will shrink slightly, will still be several percent.
The pre-election loosening of the fiscal belt and the costs of rebuilding after February’s earthquakes will bloat the budget deficit to about 5% of GDP. GDP. The artificial stabilization of the Turkish currency led to the complete erosion of foreign exchange reserves. In such circumstances, a gradual tightening of monetary policy seems doomed to failure. We also see no room for strengthening the lira. We expect USD/TRY to hit 30.00 later this year.
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