How does the unexpected interest rate decision of the Central Bank affect the exchange rate and inflation?

The Central Bank of the Republic of Turkey (CBRT) Monetary Policy Committee lowered the one-week repo auction rate, which is the policy rate, by 100 basis points from 14 percent to 13 percent.

While the opinion that the benchmark interest rate will be kept constant in the markets, exchange rates rose rapidly after this reduction decision. The dollar rose above 18 liras in the free market. The euro also rose to 18.3 liras.

In its statement, the Central Bank emphasized that ‘it has different instruments to ensure price stability’. Although not detailed in the statement, there are possible alternatives to use the foreign exchange reserves to put more dollars into the market or to make new swap agreements to keep the situation under control. Although it is not known how effective these will be, it is expected that the exchange rates will follow an upward trend in the current conditions.

While almost all of the world’s leading central banks were increasing interest rates due to high inflation concerns, an increase in interest rates was not expected in the markets due to the fact that President Recep Tayyip Erdoğan’s stance against the increase in interest rates was known. However, it was a surprise for everyone that the interest rates, which were held fixed for seven months, were further reduced.

Economists expect inflation to rise

Economists predict that after this unexpected decision, the official inflation approaching 80 percent will rise much higher.

Central banks aim to reduce the money supply by increasing policy rates in order to curb the inflation increase caused by energy and food prices worldwide. Although these decisions mean a slowdown in the economy, monetary policy managers see runaway inflation as more dangerous than short-term recessions.

The Central Bank of the Republic of Turkey, on the other hand, stated that, “The Board foresees that the disinflationary process will begin with the re-establishment of the global peace environment, together with the steps taken and determinedly implemented to strengthen sustainable price stability and financial stability,” and stated that it preferred to reduce interest rates to support the momentum gained in industrial production. stressed. In other words, the bank preferred to revive economic activity with the prediction that inflation would decrease globally.

BlueBay Asset Management Economist Timothy Ash, who focuses on emerging markets, argued that the rate cut, which he described as a “stupid move”, was made by relying on money from Russia and the Gulf.

On the other hand, apart from the interest rate decision, the Central Bank announced that the total reserves increased by 5 billion 101 million dollars in the week of August 12 compared to the previous week and reached 113 billion 738 million dollars. Turkey’s gross foreign exchange reserves have increased by 15 billion dollars in the last 3 weeks. Speaking to Bloomberg after the interest rate decision, economist Per Hammarlund commented that the increase in the Central Bank’s international reserves encouraged the policy rate to decrease.

Economist Mahfi Eğilmez commented, “The situation is similar to the fact that the person who is constantly tortured no longer feels pain and does not react in the last stages. At that stage, death can occur without warning. The last interest rate cut shows that the system has become unable to respond adequately.”

However, some economists stated that the 100 basis point cut was symbolic in a high inflation environment.

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