Has there just been a landmark change in how Turkey runs its economy? It depends on how much importance one gives to what the country’s central bank says rather than what it does. It also depends on how much of a free hand it has.

There’s clearly been a noteworthy shift – the bank, widely known for its unorthodox stance (read: its reluctance to raise interest rates) tightened policy this week in a way that had some analysts clamouring that the days of unorthodoxy were over.

Bolstered by that move, the currency has strengthened from levels of below 2.05 lira to the dollar last week to about 2.01 on Friday. The measure itself has all the complexity for which the central bank has come to be known.

Rather than adjust headline rates, as it last did in July and August, the bank decided to stop lending funds at the relatively cheap monthly repo rate. That has the effect of increasing money market rates by about 40-50 basis points, to around 7.75 per cent, since higher lending rates are now a bigger proportion of the overall mix.

Many analysts have honed in on in the bank’s language. In explaining its move on Tuesday, the central bank acknowledged inflation remains off-course – 7.7 per cent for October, compared to its own prediction of 6.8 per cent for year end and an official target of 5 per cent. It blamed this on foreign exchange volatility and said as a result it would maintain its “cautious monetary stance”.

Then, at a meeting with economists on Wednesday, the bank doubled down on the new tone, contending that Turkey did not want to deter capital inflows, that the lira was not overvalued and, in essence, that policy was now normalised.

Even previously sceptical analysts were struck by this. “This meeting marks an end to the Turkish Central Bank’s unorthodox policy,” wrote Tim Ash at Standard Bank.

Murat Ucer at GlobalSource Partners added: “The Bank is feeling compelled to be tighter and clearer. They are still behind the curve, in my view… but they certainly moved a few steps forward in the last two days. They also seemed open to hikes in the event of further market pressures [on inflation]“.

But given the limited nature and relative opacity of this week’s step, what may be most important is the message that the central bank is giving rather than the measure it has actually taken.

That raises two questions. The first concerns the likelihood that the bank can maintain its line – and tighten further – in the event of possible government pressure.

It is worth remembering that prime minister Recep Tayyip Erdogan has consistently denounced high interest rates; that this summer’s rises only came after a minsterial meeting was held on the economy; and that the atmosphere is set to become still more charged next year with historic presidential elections. Ash notes that Turkey has retained what was until this week still officially the policy rate – the one week repo rate of 4.5 per cent – even though the central bank’s technocrats insist it isn’t relevant. He terms it the “political rate” – there, not for its impact on the market, but to assuage the prime minister’s demand for low interest rates.

That leads to the second question. If, theoretically, the bank isn’t strong enough to withstand government pressure, what will Erdogan decide? Higher interest rates could reduce Turkey’s vulnerability to an external shock but leave their mark with lower growth figures and higher unemployment numbers – not necessarily what you want when you are campaigning to become your country’s first directly-elected president.

What will win the day? Politics or economics? That, ultimately, might be more significant that the subtleties of centralbank-speak and the monthly repo rate.

Related reading:
Turks bet on a falling lira by hoarding foreign currency
, FT
Turkey’s short-term debt: it’s big, but how problematic?
, beyondbrics
Turkey opts for stable interest rates as lira hits record low
, bb
Turkey raises rates to stop lira’s slide amid EM turmoil
, FT

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