Slowing Economy Gives Turkey Cover to Hold Interest Rates Again

Turkey’s central bank is poised to leave its benchmark interest rate unchanged in the face of a cooling economy and subdued foreign currency demand despite rising prices driven by the Iran war.

All but three economists in a Bloomberg survey of 21 participants expect the Monetary Policy Committee to hold the one-week repo rate at 37% for the third consecutive meeting on Thursday. JPMorgan Chase & Co is one of the few calling for borrowing costs to rise to 40%.

Since the start of the Iran war, the central bank, led by Governor Fatih Karahan, has tightened policy without touching the benchmark rate. It paused lending from the 37% facility and shifted to the costlier overnight rate of 40%.

Gross foreign exchange reserves have fallen by $20 billion since the start of the war, and the central bank has sold or swapped gold holdings to resist further pressure on the lira.

Turkey, a major oil and natural gas importer, also faced a surge in energy costs after the Strait of Hormuz was effectively closed. This has contributed to annual inflation accelerating for two straight months.

Although some economists argue that seasonally adjusted measures point to an underlying improvement in consumer prices, most see inflation ending the year around 30% — a more pessimistic outlook than the central bank’s forecast of 26%.

“We think the Turkish central bank is likely to hold rates, keep effective funding at 40%, and reassess its stance” once there’s a clearer picture of the Iran conflict, Bank of America Securities economist Hande Kucuk wrote in a note dated June 5. She added that weaker-than-expected first-quarter gross domestic product growth and low retail demand for foreign currency were likely to reinforce the bank’s view to continue with current policies.

Karahan has sent mixed signals on the path ahead. At a presentation last month, he defended April’s hold decision by citing limited deterioration in the inflation outlook and expected long-term improvement. But he also cautioned against the policy and effective funding rates differing for a long time.

Raising the policy rate to 40% would close that gap without amounting to additional tightening in practice, said Selva Demiralp, a Koc University professor and former Federal Reserve Board economist. She called for a hike at Thursday’s meeting, citing the continuation of the war and the effects of recent political turbulence in Turkey that put further pressure on reserves and rattled markets.

Defending the lira after a court ousted the leader of the main opposition Republican People’s Party in May cost some $13 billion, according to Bloomberg Economics estimates.