Turkish lira slumps to record low as central bank keeps rates on hold

Turkey’s central bank kept its benchmark interest rate on hold, surprising economists who had expected a hike. The lira slid to a record low.

The benchmark one-week repo rate will remain at 10.25 percent, the central bank said on its website on Thursday, instead announcing a widening of its so-called interest rate corridor. Polls of economists by Reuters and the state-run Anadolu news agency had forecast an increase of between 1 percentage point and 2 percentage points.

“Absolutely idiotic move by the central bank,” said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. “Just when the market was beginning to suggest there was some hope.”

The lira fell to as low as 7.9788 per dollar. It was down 1.9 percent at 7.9594 at 2:33 p.m. local time. The currency had rallied to a two-week high this week on anticipation of a hike.

“A significant tightening in financial conditions has been achieved, following the monetary policy and liquidity management steps taken to contain inflation expectations and risks to the inflation outlook,” the central bank said in a statement accompanying the decision.

Monetary policymakers raised interest rates by 2 percentage points in September, the first hike in two years. The bank has been under political pressure to keep borrowing costs low as the government sought to stimulate economic growth through a lending boom. President Recep Tayyip Erdoğan says higher interest rates are inflationary, a view that jars with conventional economic wisdom.

As selling pressure on the lira has mounted, the central bank has spent tens of billions of dollars of its foreign exchange reserves defending the currency, leaving them severely depleted, when taking account of its foreign exchange liabilities.

Monetary policymakers have raised average funding costs for banks in Turkey by using a so-called interest rate corridor with varying rates of interest. The costs had increased to more than 12 percent before Thursday's decision, from around 10.5 percent in September.

Rather than raise the benchmark rate, the central bank said on Thursday that it set the margin between its overnight lending rate and higher so-called late liquidity window rate at 3 percentage points. The overnight lending rate stands at 11.75 percent. The late liquidity window was previously set at 13.25 percent.

"Widening the effective corridor creates more uncertainty at a time when Turkey needs less," said Erik Meyersson, senior economist at Handelsbanken. "The central bank can in theory set the effective policy stance tomorrow at 14.75% and 8.75% the day after. Investors need to take this into account too."

Inflation in Turkey stands at 11.8 percent, meaning returns for deposit account holders and investors in government bonds are low. That has caused Turkish savers to buy dollars, other foreign currencies, gold and bitcoin to protect their capital.

(Story was updated with economist comment in 10th paragraph.)