Turkey: MPC raises policy rate by 750bps to 25.0%, more than expected

• Hike significantly exceeds expectations, in our view with the aim to improve credibility of new approach
• Monetary tightening continues in order to support disinflation, anchor inflation expectations
• Rate hikes to continue in a gradual way, along with monetary policy simplification

The MPC raised the policy rate by 750bps to 25.0% on the rate-setting meeting in August, the CBT announced. A rate hike was expected but its size came as a significant surprise to markets, which had on average expected a much more subdued hike of 250bps. This was also the steepest rate hike since the CBT management reshuffle after the elections in May. We think the strong rate hike meant to address market concerns that the CBT wanted to avoid significant rate hike. The concerns appeared after the restructuring of the FX-protected deposit scheme (KKM) in the beginning of this week, in which the CBT imposed a target ratio of converting KKM deposits into conventional lira deposits and imposed the security maintenance rule on banks which fail to meet the ratio. The CBT was criticised for transferring the burden of supporting the lira exchange rate on banks rather than using a regular policy rate hike to support the lira. In this context, we consider the unexpectedly strong rate hike as an effort from the MPC to maintain the credibility of its new policy for return to orthodox policy framework.

The MPC decided to continue the monetary tightening in order to foster disinflation as soon as possible, anchor inflation expectations and control the deterioration in pricing behaviour, the MPC said in the press release after the meeting. The MPC did not explicitly justify the need for a much higher rate hike than in the previous couple of months but said that recent data suggested continued increase in core inflation. Strong demand, cost pressures from wages and exchange rates, tax hikes and sticky services inflation accounted for the negative inflation outlook, it said. It implied that the inflation outlook changed unfavourably since the July Inflation Report, saying that end-year inflation could be close to the upper bound of the report's forecast range. The CBT had projected in the July Inflation Report that end-2023 inflation will be in the 54-62% range with a 70% probability with a mid-point of 58.0%. The CBT maintained its expectations for disinflation in 2024 in line with the July report, because of the monetary tightening process.

The policy rate will be set so that the mid-term inflation target of 5% is achieved in the mid-term and the underlying inflation trend will decelerate as well, the MPC stressed. It signalled further monetary tightening, saying that the process will be further strengthened as much as necessary and in a timely and gradual manner until there is significant improvement in the inflation outlook. The simplification of the monetary policy framework will also continue gradually, it added. The recent change of the FX-protected deposit scheme will strengthen the monetary transmission mechanism and the MPC will implement quantitative and selective credit tightening, in addition to the policy rate, in order to support the monetary policy stance, the MPC underlined.