Turkey Faces Rates Impasse as Inflation Hits 20-Year High

Turkey’s inflation accelerated to its highest level since President Recep Tayyip Erdogan took power two decades ago, challenging a push for lower borrowing costs that’s battered the lira and hit his working class base ahead of next year’s elections.

Consumer price inflation surged to an annual 48.7% last month, the highest since April 2002, leaving the central bank in a tricky position where raising rates will anger Erdogan but cutting them will only add to runaway price increases.

Under pressure from the president, who’s keen to boost growth ahead of the 2023 polls, Turkey’s central bank has slashed its policy rate by 500 basis points to 14%, or negative 35% when adjusted for inflation, the lowest real yield across emerging markets. That’s sent the lira into a tailspin and accelerated the surge in consumer prices.

Global pressures, including a jump in the cost of gas and other commodities, exacerbated price increases in January and have also cast a pall over the medium-term inflation outlook.

Turkey’s central bank held rates steady in January as prices soared but Erdogan, who espouses the unorthodox view that higher borrowing costs fuel inflation, signaled last week that he had no intention of abandoning his overall policy trajectory.

That’s frustrated investors who have dumped the lira and complained that Turkey’s monetary policy has become unpredictable, driven more by Erdogan’s policy whims than economic fundamentals.

“I think the central bank will be forced to hike, whether they like it or not,” said Cristian Maggio, head of portfolio strategy at TD Securities. “However, I cannot rule out an attempt to ease further before they are forced to U-turn,” he said. “Sure enough CPI at around 50% is a total failure by the central bank.”

The lira, which slid by more than 44% last year, was trading 0.9% lower at 13.5855 per dollar as of 1:11 p.m. in Istanbul.

The sharp price increases—inflation rose 11.1% through last month alone and annual producer inflation breached 93% — pose a political challenge for Erdogan, who faces elections in 2023.

A former Istanbul mayor, he took power at a time of deep public frustration over falling living standards and economic malaise. His party presided over more than a decade of growth, often fueled by pre-election credit expansion. But the economy has faced challenges in recent years, hit by a recession that was followed swiftly by the Covid-19 pandemic.

Erdogan’s popularity among voters was slipping in late 2021 before he moved to increase the minimum wage by 50%. January data shows that the consumer inflation rate has now wiped out most of the pay rise.

January is traditionally a high inflation month in Turkey as cold weather pressures food prices and the government adjusts some taxes according to inflation rates recorded the previous year. This time, higher energy prices and household utility costs also took their toll.

The rate of inflation in energy rose to 76.4% from 42.9% in December. The government unveiled historic increases of as much as 130% in the price of household electricity in January. Annual retail inflation in Istanbul, the biggest city and commercial capital of Turkey, reached 50.9% in January, jumping from 34.2% a month earlier.

The price of benchmark Brent crude, an indicator of corporate Turkey’s energy bills, hovered around a seven-year high in January, prompting analysts to raise their producer-price estimates to near triple digits on an annual basis.

Central bank governor Sahap Kavcioglu has said that support for the local currency would be a key objective this year but has shown little sign that will involve a tighter monetary policy stance. The central bank is hoping to curb price growth by taking measures to encourage de-dollarization, though each wave of lira weakness has only pushed Turks to buy the U.S. currency as a safe haven and store of value.

The surge in commodity prices will continue adding to inflationary pressure, according to Istanbul Analytics economist Guldem Atabay. “The pass through from producers’ price inflation will push the annual consumer inflation to 55-60% levels swiftly by the end of first quarter,” she said before the data was released.

Turkey’s central bank will publish current-account data for both December and full-year 2021 on Feb. 11. Kavcioglu will chair the next rate-setting meeting on Feb. 17.

—With assistance from Harumi Ichikura.