Turkey’s central bank sharply raises interest rates. That could signal an economic turnaround

ANKARA, Turkey (AP) — Turkey’s central bank delivered a large interest rate hike Thursday, signaling a shift toward more conventional economic policies to counter sky-high inflation following criticism that President Recep Tayyip Erdogan’s approach has made a cost-of-living crisis worse.

The bank raised its key rate by 6.5 percentage points, boosting it to 15%. The increase — a jump from the current 8.5% — is the first since March 2021 but is lower than market expectations.

It came at the bank’s closely watched first interest rate-setting meeting since Erdogan appointed two internationally respected officials to lead the bank and the finance ministry. The rate hike is an indication that the country is moving away from Erdogan’s unorthodox belief that lowering interest rates fights inflation.

Traditional economic theory says just the opposite, and central banks worldwide have rapidly raised rates to combat spikes in consumer prices tied to the rebound from the pandemic and Russia’s invasion of Ukraine. There were several hikes across Europe on Thursday, ranging from the Bank of England to the Swiss National Bank.

Erdogan — a self-declared “enemy” of high borrowing costs — has said he would “accept” his new finance minister’s policies but also insisted that his views have not changed. That led to questions about whether Turkey’s central bank could act independently.

A statement from the bank’s Monetary Policy Committee said it had decided to begin “the monetary tightening process in order to establish the disinflation course as soon as possible.”

“Monetary tightening will be further strengthened as much as needed in a timely and gradual manner until a significant improvement in the inflation outlook is achieved,” it said.

Hamish Kinnear, senior analyst at the risk intelligence company Verisk Maplecroft, said increase from 8.5% to 15% “marks a return to more orthodox monetary policymaking.”

But it was lower than market expectations of an increase of 17% to 20%, he said.

“This is a sign that the new governor is looking to tread carefully to avoid a clash with President Erdogan,” Kinnear said in a note.

Under pressure from Erdogan, the central bank had cut its key interest rate from around 19% in 2021 to 8.5% earlier this year, despite soaring inflation that hit an eye-watering 85% last year.

Inflation has eased to 39.5% last month, according to official figures, but independent research group ENAG says the true rate is 109%.

Economists say Erdogan’s unconventional belief has exacerbated economic turmoil, leading to currency and cost-of-living crises that have brought hardship to many households struggling to afford food, housing and other necessities. Erdogan says his economic model prioritizes growth, exports and employment.

Experts also say the central bank has depleted its foreign currency reserves as it tried to prop up the Turkish lira ahead of elections last month. The currency has lost around 21% of its value against the dollar since the start of the year.

On Thursday, the lira weakened by 3% against the dollar due to the lower-than-expected rate hike.

Erdogan, who won a third term in a runoff election May 28, reappointed Mehmet Simsek to the helm of the economy. The former Merrill Lynch banker had previously served as Erdogan’s finance minister and as a deputy prime minister until 2018.

Simsek said soon after his appointment that Turkey had no other option but to return to a “rational ground.”

In another sign of a move toward more pragmatic policies, Erdogan appointed Hafize Gaye Erkan this month as Turkey’s first female central bank governor. A former co-chief executive of the now-failed San Francisco-based First Republic Bank, Erkan replaced Sahap Kavcioglu, who oversaw a series of rate cuts.

“For now, Erdogan is happy to cede economic policymaking power to Governor Erkan and the new finance minister, Mehmet Simsek, so that Turkey can draw in much-needed foreign investment,” said Kinnear, the analyst.

“But if the likely impacts of orthodox policies, such as slowing economic growth from interest rate hikes, appear to threaten the president’s popularity, he could perform a volte-face and fire the new central bank governor,” Kinnear said.

Erdogan had fired three central bank governors who resisted pressure to cut interest rates before appointing Kavcioglu in 2021. Naci Agbal, who proceeded Kavcioglu, was removed from his post days after he raised rates.

Can Selcuki, director of the Turkiye Raporu polling agency and a former World Bank economist for Turkey, also said questions remain about whether the new officials would be able to “stick to their preferred policy” as the country heads to local elections in March.

“What needs to be done right now is some form of tightening, and that is an undesired process for any incumbent before elections,” he said.

On Tuesday, the government increased the minimum wage by 34% — a move that critics say is designed to ease the impact of inflation on households in the runup to next year’s vote.

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Wieting reported from Istanbul. AP videojournalist Mehmet Guzel contributed from Istanbul.

Suzan Fraser And Ayse Wieting, The Associated Press