Opinions Joost Derks
In this country, 40 percent interest rates cannot extinguish inflation
Inflation in Turkey is threatening to spiral out of control again. In recent years, however, the central bank has been increasingly focused on curbing high inflation. Whether this trend will continue, and what it means for the lira, will become clear on October 23rd.
Life seems to be getting more and more expensive. It's emotionally jarring every time you pay for a full basket of groceries at the supermarket, but the official confirmation came again last week from Statistics Netherlands (CBS). Inflation reached 3,3% in September, down from 2,8% in August. However, the average price increase is child's play compared to what's happening in Turkey. Last month, inflation there reached 33,3%. That's a significant setback. Incidentally, the pain wasn't even in the speed at which retail prices were rising, as in recent years, inflation in Turkey has been above 50% for longer periods than below.
Painful change
The inflation figure hit hard, particularly because it was higher than the previous month for the first time in over a year. Since the spring of 2024, inflation has actually seen a nice slide from over 75% to just under 33% in August of this year. This sharp decline is primarily due to the exchange rate reversal at the Turkish Central Bank (CBT). Although the inflation decline occurred primarily during the administration of Chairman Fatih Karahan, it is largely thanks to Hafizı Gaye Erkan that the economy has not completely derailed. After taking office in early June 2023, she raised the policy rate from 8,5% to 45% in just over six months. Karahan then raised the rate slightly to 50% after taking office, before lowering it again slightly.
Mechanism not working
A high policy rate often works to a currency's advantage. A relatively attractive interest rate can entice many investors to hold their assets in the currency. However, this mechanism is hardly evident with the lira. A key reason is that inflation has long been significantly higher than the policy rate. This erodes the purchasing power of lira-denominated assets, despite the seemingly attractive interest rate. Furthermore, financial markets have little confidence in the bank. Until a year and a half ago, under pressure from President Recep Tayyip Erdoğan, the bank kept the policy rate far too low in an attempt to stimulate the economy.
Regain trust
A lot of water still needs to flow through the Bosphorus before traders consider the CBT truly independent. In that respect, it would be beneficial if the modest rise in inflation puts a brake on Karahan's plans to further cut interest rates. On paper, the 25,9% inflation rate since the turn of the year is still within the 25% to 29% range initially forecast by the central bank. The next interest rate decision will be made on October 23. Economists expect a rate cut from 40,5% to 39%. If Karahan resists the temptation to give the economy some breathing room with lower interest rates, it would be a signal that the CBT is truly committed to combating inflation. That would be good news for the lira, but for now, the end of the Turkish currency's freefall does not seem to be in sight.
Joost Derks
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