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Turkey's Central Bank Promises Action after Inflation Surges to 18%

Turkish lira banknotes are pictured at a currency exchange office in Istanbul, Turkey, Aug. 13, 2018.

Turkey's central bank said it would adjust its monetary stance given “significant risks” to price stability, a rare move to calm financial markets after inflation surged to its highest in nearly a decade and a half on Monday.

The comments from the central bank underscore the volatile outlook for prices amid a currency crisis. The lira has lost 40 percent of its value against the dollar this year, driving up the cost of goods from potatoes to petrol and sparking alarm about the impact on the wider economy and the banking system.

Inflation jumped 17.9 percent year-on-year in August, official data showed, outstripping market expectations and marking its highest level since late 2003.

“Recent developments regarding the inflation outlook indicate significant risks to price stability. The central bank will take the necessary actions to support price stability,” the bank said in a statement.

“(The) monetary stance will be adjusted at the September monetary policy committee meeting in view of the latest developments.”

For investors, the main question has been whether the central bank will be able to sufficiently hike interest rates at its next policy-setting meeting on Sept. 13 to tame inflation. It left rates on hold at its last meeting in July, confounding expectations and sending the lira sharply weaker.

President Tayyip Erdogan, a self-described “enemy of interest rates,” wants to see lower borrowing costs to keep credit-fuelled growth on track. Investors, who fear the economy is set for a hard landing, want big rate hikes.

Berat Albayrak, Turkey's Treasury and Finance Minister, talks during a conference in Istanbul, Aug. 10, 2018, in a bid to ease investor concerns about Turkey's economic policy.
Berat Albayrak, Turkey's Treasury and Finance Minister, talks during a conference in Istanbul, Aug. 10, 2018, in a bid to ease investor concerns about Turkey's economic policy.

Finance Minister Berat Albayrak told Reuters in an interview on Sunday that the bank was independent of the government and would take all necessary steps to combat inflation. He also promised a “full-fledged fight” against inflation.

By signalling that it was ready to take action, the central bank may now have inadvertently set financial markets up for disappointment if it doesn't deliver a hefty increase, said Piotr Matys, an emerging markets forex strategist at Rabobank.

“A proper rate hike is required and by making a pledge to raise interest rates, the central bank may have raised the bar for itself to exceed expectations on Sept. 13,” Matys said. “The central bank basically has no room to disappoint.”

Not enough

The lira briefly recovered some losses immediately after the central bank's announcement. By 0852 GMT it was more than 1 percent weaker on the day at 6.6200 to the dollar.

The bank is likely to deliver a rate hike of 2 percentage points on Sept. 13, far short of the 7-10 percentage points that investors would like to see, said Jason Tuvey of Capital Economics in a note to clients.

Such increases are needed “to bring real interest rates back to positive territory and reassure the markets that policymakers are willing and able to tackle high inflation,” he said.

Inflation jumped 2.3 percent from the previous month, the data from the Turkish Statistical Institute also showed, higher than the 2.23 percent forecast in a Reuters poll.

Producer prices rose 6.6 percent month-on-month in August for an annual rise of 32.13 percent.