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Turkey’s central has opted to keep its main interest rates on hold this month despite a fresh bout of weakness in the country’s currency following a major diplomatic dispute with the Netherlands that threatens to sour Turkish relations with the EU.

Policymakers at the Turkish central bank (CBRT) voted to hold steady on any changes to their overnight borrowing, lending and repo rates having raised the overnight lending rate by 0.75 percentage points in January to halt a punishing decline in the lira.

They did however vote to raise a late liquidity window from 11 per cent to 11.75 per cent – in line with an average forecast of economists compiled by Bloomberg.

The lira accelerated its gains, leaping 0.9 per cent higher on the day following the move, at TRY3.6380. It had been trading 0.35 per cent higher before the decision.

Turkish policymakers face a tricky balancing act in their bid to balance a slowing economy with double-digit inflation which has been pushed up by a weak currency. Annual inflation topped 10 per cent for the first time in nearly five years while unemployment also climbed at the end of last year.

In a statement, the Turkish central bank said they had decided to “strengthen monetary tightening in order to contain the deterioration in the inflation outlook”.

“The significant rise in inflation is expected to continue in the short term due to lagged pass-through and the base effect in food prices”, added the CBRT, which also promised to keep rates elevated to contain price pressures:

The Central Bank will continue to use all available instruments in pursuit of the price stability objective.

Tight stance in monetary policy will be maintained until inflation outlook displays a significant improvement. Inflation expectations, pricing behavior and other factors affecting inflation will be closely monitored and, if needed, further monetary tightening will be delivered.

Investors have shunned the lira this week after Ankara’s conservative AKP government has been embroiled in a row with the Netherlands that has led to accusations of “Nazism” and threats of Turkey’s refugee deal with the EU. Markets have also been jittery ahead of a major constitutional referendum to award unprecedented powers to the president.

The tumbling exchange rate – the worst performing major emerging market currency this year – has forced the central bank to make tweaks to a range of its monetary policy tools to support the lira in recent months.

Tim Ash at Bluebay Asset Management said the March decision was in line with the “dynamic tightening” approach adopted by the central bank but thinks the measures could soon unwind after the April referendum.

“Thereafter the CBRT likely to move to loosen fairly quickly as the focus moves back to growth”, said Mr Ash.

First chart via Bloomberg

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