It’s a battle that neither side is destined to win. Last week, Turkish president Recep Tayyip Erdogan picked another fight with the country’s central bank, spooking investors already worried about the institution’s independence. Erdogan said on Nov. 17 that the bank’s officials were on the “wrong path” by raising interest rates to battle inflation.
Turkey’s annual core inflation rate, which excludes food and energy, hit its highest level in 13 years last month, at 11.8%. Traditionally, central banks raise interest rates in an effort to tame inflation. Erdogan, however, seems to believe that high interest rates cause inflation. In the past, he even suggested that resistance to rate cuts was akin to treason. The central bank has resisted political pressure anyway (paywall), keeping rates at relatively high levels.
This puts the central bank is in a bind. Political instability, economic concerns, an increasingly tense relationship with the US, and a recent spat with NATO are leading investors to flee from Turkish assets. This makes the lira weaker, which in turn is making the central bank’s inflation problem more difficult. The more urgently it needs to raise interest rates, the more strongly Erdogan comes out against it. The signs of meddling worry investors and the cycle continues.
Policymakers are struggling to stem the decline in the lira. Over the weekend, the central bank said it would auction as much as $3 billion in securities to help corporate borrowers manage their currency positions. This didn’t help much; the lira fell 1.3% yesterday against the dollar. The central bank tried again today, announcing a change to borrowing terms for banks that essentially amounts to a 25 basis point increase in their funding costs. Still, the lira fell further.
For many investors, nothing but a massive interest rate hike will be enough. “A complete joke— like 25 basis points will make any difference,” said Timothy Ash, a strategist at BlueBay Asset Management. The next central bank policy meeting isn’t until mid-December, but given Erdogan’s opposition to higher rates its hard to see how the bank will effectively bring down inflation with traditional tools. As the central bank loses credibility, the lira comes under more pressure, and nobody is happy.