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Turkey cuts interest rates again despite 80% inflation

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Russian tourists to Europe fell sharply this summer, but increased in some other destinations, including Turkey ( here ).

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Turkey’s central bank surprised markets again with its decision to cut its key interest rate on Thursday, despite inflation in the country exceeding 80%.

The country’s monetary policymakers opted for a 100 basis point cut, bringing the key one-week repo rate from 13% to 12%. Turkey’s inflation rate was recorded at 80.2% in August, accelerating for the 15th consecutive month and the highest level in 24 years.

Turkey also cut rates by 100 basis points in August and gradually cut interest rates by 500 basis points at the end of 2021, triggering the currency crisis.

In a statement, the Central Bank of the Republic of Turkey said it “assessed that the updated policy level is in line with current forecasts,” according to Reuters. It said the cut was necessary as growth and demand continued to slow, and cited “escalating geopolitical risk”.

It said that markets should expect “the process of disinflation to begin” amid the measures taken, Reuters reports.

The policy direction has long baffled investors and economists, who say the refusal to tighten policy is the result of political pressure from Turkish President Recep Tayyip Erdogan, who has long opposed interest rates and turned against economic orthodoxy by insisting that lowering rates is the way to beat inflation.

People look at gold jewelry in the window of a gold shop in Istanbul’s Grand Bazaar on May 5, 2022 in Istanbul, Turkey. Gold prices rose on Monday as the dollar hovered near recent lows and investors focused on a key U.S. inflation measure as it could influence the size of the Federal Reserve’s next interest rate hike.

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A months-long campaign to cut rates incessantly as Turkey’s trade and current account deficits widen and its foreign reserves run dry has instead led to a multi-year corkscrew for Turkey’s currency, the lira.

Lira lost more than 27% of its value dollar since the beginning of the year and 80% in the last five years. After the bank’s rate announcement, the currency fell by a quarter of a percentage point, trading at a record low of 18.379 per dollar.

More dangers lie ahead for the lira

Many economists predict a further fall of the lira. Capital Economics, based in London, predicts it will fall to 24 to the dollar by March 2023.

“The room for further easing is becoming increasingly limited because of the pressure this is putting on the lira and real rates,” Liam Peach, the firm’s senior emerging markets economist, told CNBC. “Turkey has such a large current account deficit and it has become dependent on foreign capital inflows to finance it. Turkey’s foreign exchange reserves are so low that the central bank is really unable to intervene,” he said.

At some point, confidence will become so low that these vital inflows are likely to dry up, warned Piech: “Further interest rate cuts make it difficult for Turkey to attract these capital flows.”

An electronic scoreboard displays exchange rate information at a currency exchange office in Istanbul, Turkey, Monday, Aug. 29, 2022.

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Meanwhile, Erdogan remains optimistic, predicting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview on Tuesday. Erdogan is not an economist by education.

Turks will likely continue to struggle as their basic living costs rise, and Russia continues to do so war in Ukraine dramatically worsened commodity and energy price inflation worldwide.

But ultimately, said Eric Meyerson, senior economist at Stockholm’s Handelsbanken Capital Markets, “the most pressing issue is the mismanagement of the domestic economy by the ruling regime.”

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