Turkish lira banknotes sit in this arranged photograph at a currency exchange in Istanbul, Turkey, on Friday, March 16, 2018. As Turkish markets tumble, investor attention is turning once more to the central bank for signs it’s willing to backstop the nation’s assets. Photographer: Kostas Tsironis/Bloomberg
The fall of the lira has triggered concern that it could lead to a sharp slowdown in growth © Bloomberg

Turkey’s central bank has sought to calm financial markets by promising to simplify its complex system of interest rates, triggering the biggest leap in the lira in more than a year.

The decision announced on Monday will boost hopes among investors that the central bank has been granted more latitude after a weeks-long stand-off with president Recep Tayyip Erdogan that caused the currency to plunge to record lows.

The central bank said it would more than double its one-week repo rate to 16.5 per cent from June 1, setting it as the benchmark and marking a return to a more conventional approach to monetary policy.

“It seems the orthodox economists are winning in Turkey, first with a 300 basis points rate hike, now a realistic repo rate,” said Charles Robertson, global chief economist at Renaissance Capital.

The lira was up more than 3 per cent against the dollar following the central bank announcement.

Mr Erdogan is a longstanding opponent of high interest rates, and continued to rail against a rate increase even as the lira lost 20 per cent of its value against the dollar since the start of the year. But after heavy pressure from some members of his economics and finance team, he relented last week and the central bank raised its liquidity window rate from 13.5 per cent to 16.5 per cent.

The late liquidity window allows banks to borrow after local markets have closed and has become the de facto main rate. But after an initial recovery in the lira, the currency continued to lose value as investors were unconvinced that the move would be sufficient to stem the deepening crisis.

It is widely believed that it was Mr Erdogan’s hostility to high interest rates that compelled the central bank in January 2017 to adopt the unorthodox tactic of raising the late liquidity window and then forcing all lenders to borrow using that rate. It had previously been used as a last resort for banks that were not receiving adequate funding at the cheaper repo rate.

But for years the bank has relied on a complicated system of multiple rates that analysts said made monetary policy decisions unpredictable.

In a statement published on its website, the central bank said it was effectively switching that rate with the one-week repo rate. Overnight borrowing and lending rates will be set 150bp high than the one-week repo rate, it said.

Speaking after the announcement, Nihat Zeybekci, the economy minister and an Erdogan loyalist, said the government fully supported the move.

The lira gained to 4.6070 against the US dollar after the statement, from a close of 4.7052 on Friday. It was still 18 per cent weaker since the start of the year.

Timothy Ash, senior emerging market sovereign strategist at BlueBay Asset Management, said the “more rigid” rate regime would be seen by investors as “a positive.” He added that the changes were “long overdue”.

The falling currency had triggered growing concern in recent weeks among economists, who had warned that it could lead to a sharp slowdown in growth or even a recession if the central bank failed to stop the slide.

Analysts were especially worried about the impact on the Turkish corporate sector and the banking system. Turkish companies hold $295bn of foreign currency debt. For companies with revenues predominantly in lira, the weaker currency has made those loans increasingly expensive to service.

Murat Cetinkaya, the central bank governor, and Mehmet Simsek, Turkey’s deputy prime minister, were due to travel to London on Monday for two days of meetings aimed at calming investors.

Yet in a sign of the conflicting messages emanating from Turkey, Mr Erdogan on Saturday again cast the currency’s woes as the work of a foreign conspiracy. “Hey, finance sector, you will pay a heavy price for playing such games with our investors,” he told a rally in the eastern city of Erzurum, where he was campaigning ahead of crucial elections next month.

He urged Turkish citizens to convert their dollars and euros to lira, vowing: “Together we will foil this plot.”

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