Turkish lira trades at record low after Erdoğan rate cut demands met

Turkey’s beleaguered lira traded at a record low against the dollar after the central bank shocked investors by cutting interest rates.

The reduction in borrowing costs to 18 percent from 19 percent was ordered by President Recep Tayyip Erdoğan. The central bank sanctioned the move on Friday even after inflation accelerated from 18.99 percent to 19.25 percent last month, the highest level in major emerging markets outside of crisis-hit Argentina.

The lira fell to as low as 8.89 per dollar on Monday morning before recovering to trade up 0.2 percent at 8.86 against the U.S. currency. It dropped to 8.9 per dollar on Friday, when the central bank’s monetary policy committee approved the rate cut.

Turkey’s central bank has its hands tied in tackling inflation because Erdoğan insists that higher borrowing costs stoke inflation. That view jars with conventional economic theory that states that monetary authorities can raise borrowing costs to slow price increases.

A member of Turkey’s rate-setting committee was absent from Friday’s meeting after contracting the COVID-19 virus, Bloomberg reported on Monday citing sources that it did not identify. Abdullah Yavaş, a committee member since 2008, could not even attend virtually, the people said.

Erdoğan has sacked and replaced a majority of the members of the monetary policy committee, including three central bank governors in a little over two years.

“Turkey's interest rates are an outlier (red), far above other emerging markets. That attracts volatile hot money inflows that don't give you foreign exchange stability,” said Robin Brooks, chief economist of the Institute of International Finance (IIF). “If you're overvalued, which we think lira is, better to get out of this equilibrium.”

The IIF has set a fair value of 9.5 per dollar for the lira.

A Reuters survey last week found 18 of 19 economists expected rates to be held for a sixth consecutive month. Only one expected a cut.

Central bank governor Şahap Kavcıoğlu had previously pledged to keep interest rates at or above current and anticipated inflation. Consumer price inflation, the central bank’s traditional focus, accelerated to 19.25 percent from 18.95 percent in August.

Justifying the rate cut, the central bank said inflation had been driven by “transitory” factors related to the reopening of the economy after COVID-19 measures were eased in June. 

Tim Ash, senior strategist for emerging markets at BlueBay Asset Management in London, said on Friday the decision was “insane”.

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