Slowing Economy Gives Turkey Cover to Hold Interest Rates Again

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(Bloomberg) — Turkey’s central bank is poised to leave its benchmark interest rate unchanged in the face of a cooling economy and subdued foreign currency demand despite rising prices driven by the Iran war.

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All but three economists in a Bloomberg survey of 21 participants expect the Monetary Policy Committee to hold the one-week repo rate at 37% for the third consecutive meeting on Thursday. JPMorgan Chase & Co is one of the few calling for borrowing costs to rise to 40%.

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Since the start of the Iran war, the central bank, led by Governor Fatih Karahan, has tightened policy without touching the benchmark rate. It paused lending from the 37% facility and shifted to the costlier overnight rate of 40%.

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Gross foreign exchange reserves have fallen by $20 billion since the start of the war, and the central bank has sold or swapped gold holdings to resist further pressure on the lira.

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Turkey, a major oil and natural gas importer, also faced a surge in energy costs after the Strait of Hormuz was effectively closed. This has contributed to annual inflation accelerating for two straight months.

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Although some economists argue that seasonally adjusted measures point to an underlying improvement in consumer prices, most see inflation ending the year around 30% — a more pessimistic outlook than the central bank’s forecast of 26%.

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“We think the Turkish central bank is likely to hold rates, keep effective funding at 40%, and reassess its stance” once there’s a clearer picture of the Iran conflict, Bank of America Securities economist Hande Kucuk wrote in a note dated June 5. She added that weaker-than-expected first-quarter gross domestic product growth and low retail demand for foreign currency were likely to reinforce the bank’s view to continue with current policies.

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Karahan has sent mixed signals on the path ahead. At a presentation last month, he defended April’s hold decision by citing limited deterioration in the inflation outlook and expected long-term improvement. But he also cautioned against the policy and effective funding rates differing for a long time.

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Raising the policy rate to 40% would close that gap without amounting to additional tightening in practice, said Selva Demiralp, a Koc University professor and former Federal Reserve Board economist. She called for a hike at Thursday’s meeting, citing the continuation of the war and the effects of recent political turbulence in Turkey that put further pressure on reserves and rattled markets.

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Defending the lira after a court ousted the leader of the main opposition Republican People’s Party in May cost some $13 billion, according to Bloomberg Economics estimates.

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