Turkey’s Central Bank surprises markets with sharp rate cut

The Central Bank of the Republic of Turkey (CBRT) has cut its benchmark one-week repo rate by 250 basis points, bringing it down to 47.5%. The move exceeded economists’ forecasts of a 150-basis-point reduction and marked a shift in monetary policy after eight consecutive meetings.

The decision comes amid a consistent decline in inflation, with November’s annual consumer price index (CPI) falling to 47.09%, the lowest level since June 2023. This represents the sixth consecutive month of disinflation, down from 48.58% in October. On a monthly basis, inflation rose by 2.24%, the smallest increase in five months.

Disinflationary momentum strengthens in Turkey

The CBRT stated that “leading indicators point to a decline in the underlying trend in December”, with domestic demand continuing to moderate. While core goods inflation remains subdued, service sector prices are showing signs of improvement. Unprocessed food inflation, which had been elevated, appears to have eased in December.

The central bank noted that the tight monetary stance is bolstering disinflation by moderating domestic demand, fostering real appreciation in the Turkish lira, and improving inflation expectations.

However, it cautioned that inflation risks persisted and pledged to maintain a prudent approach to monetary policy, adjusting its stance on a meeting-by-meeting basis.

Looking ahead, the CBRT reiterated its medium-term inflation target of 5%, with a tolerance band of 2%, while projecting inflation to decline to 21% by the end of 2025 and 12% by the end of 2026.

“We think the new set of projections is now more attainable, but the projected delay in the disinflation process will likely attract some attention”, Muhammet Merkan, economist at ING Group, said recently.

Improved credit rating and economic outlook

Turkey’s recent economic stabilisation efforts have garnered international recognition. In November, Standard & Poor’s upgraded Turkey’s long-term sovereign credit rating to BB- from B+, citing improved monetary policy, stabilisation of the lira, and rebuilding of foreign currency reserves.

The agency highlighted a narrowing current account deficit, now reduced by about four percentage points of gross domestic product since 2022, as a positive signal.

Similarly, a recent report by BBVA commended the CBRT’s foreign reserve accumulation and noted the bank’s return to being a net foreign currency buyer.

Despite these achievements, challenges remain. The Organisation for Economic Co-operation and Development (OECD) forecasts Turkey’s GDP growth to slow to 3.5% in 2024 and 2.6% in 2025, reflecting the impact of necessary macroeconomic stabilisation measures.

Market reactions

The Turkish lira remained stable following the rate cut decision, with the euro-lira exchange rate holding steady at 36.61.

Since November, the lira has strengthened by 2% against the euro, though it has weakened by 12% against the single currency over the course of 2024.

As Turkey navigates its path to sustained disinflation and economic rebalancing, the CBRT’s strategy of maintaining tight monetary policy while fostering coordination with fiscal measures will be crucial in achieving long-term stability.