Defying political pressure to reduce borrowing costs, Turkey’s central bank delivered its first rate hike in nearly three years on November 24 in a bid to support the local currency, which has been hitting successive all-time lows over the past month. 

The central bank’s Monetary Policy Committee (MPC) decided to raise its main policy rate (one-week repo rate) by 50bp to 8% as well as the upper limit of its interest rate corridor (overnight lending rate) by 25bp to 8.5%. The bank also hiked its late liquidity window lending rate by 25bp to 10%, while the late liquidity window borrowing rate was kept at 0%. The overnight borrowing rate remained unchanged at 7.25%.

The bank also cut the foreign exchange reserve requirement ratios for all maturity brackets by 50bps in a move to provide about $1.5bn additional liquidity to the financial system, the monetary authority said in a separate statement on November 24. 

The decision to begin the tightening cycle was clearly motivated by the fall in the lira, which is down by 9% against the US dollar so far this month – the most in the EM world and even more than the Mexican peso, analysts at Capital Economics write in a note.

The lira rose 0.5% on the rate hike news to trade at 3.3801 against the dollar as of 14.02 Istanbul time. It later, however, reversed the gains to hit a new fresh all-time-low of 3.4444 in a sign that the rate hike was not enough to counter the impact of higher U.S. interest rates. The benchmark  BIST-100 index was up 0.61% d/d.  

The analysts expect the lira to remain under pressure next year too. “After all, Turkey continues to run a large current account deficit (at close to 5% of GDP) and is one of the most vulnerable EMs to Fed tightening, which we expect to be more aggressive than the markets anticipate,” Capital Economics suggests.

“Against that backdrop, we see the Turkish MPC raising interest rates further next year. Weak economic growth and government pressure to keep interest rates low means the tightening cycle may be a stop-start process. Overall, however, we see the overnight lending rate being raised to 10.0% by the end of next year,” the analysts suggest.

The Committee decided to implement monetary tightening to contain adverse impact of recent exchange rate fluctuations on expectations and the pricing behavior, the MPC said in a press release after its rate-setting meeting. The slowdown in aggregate demand contributes to the fall in inflation, while exchange rate movements due to recently heightened global uncertainty and volatility pose upside risks on the inflation outlook, according to the Committee.

The MPC will maintain its cautious monetary policy stance and any new data may lead the Committee to revise its stance, the statement reads.

Rate setters also reiterated their view that economic activity will recover in the last quarter of this year thanks to the supportive measures and incentives provided recently.

In a fresh move to support the private sector, which has been facing difficulties with foreign debt repayments, the central bank announced on November 24 another decision regarding the export and foreign exchange earning rediscount credits, which will be due by December 31. Accordingly, the maximum maturity can be extended till March 31, 2017, while in case of payment on maturity without utilising the maturity extension option, credit repayments can be made in Turkish liras and the central bank buying exchange rates prevailing on the maturity date will be used in these transactions.

Turkish private sector is significantly exposed to foreign currency risk due to its heavy external debt stock.

Turkish Central Bank Policy Rates (%)
Date	one-week repo	Date	overnight borrowing	overnight lending	Date	late liquidity borrowing	late liquidity lending
May-10	7.00	Jul-13	3.50	7.25	May-13	0.00	9.50
Dec-10	6.50	Aug-13	3.50	7.75	Jul-13	0.00	10.25
Jan-11	6.25	Jan-14	8.00	12.00	Jan-14	0.00	15.00
Aug-11	5.75	Jul-14	7.50	12.00	Apr-14	0.00	13.50
Dec-12	5.50	Aug-14	7.50	11.25	Aug-14	0.00	12.75
Apr-13	5.00	Feb-15	7.25	10.75	Feb-15	0.00	12.25
May-13	4.50	Mar-16	7.25	10.50	Mar-16	0.00	12.00
Jan-14	10.00	Apr-16	7.25	10.00	Apr-16	0.00	11.50
May-14	9.50	May-16	7.25	9.50	May-16	0.00	11.00
Jun-14	8.75	Jun-16	7.25	9.00	Jun-16	0.00	10.50
Jul-14	8.25	Jul-16	7.25	8.75	Jul-16	0.00	10.25
Jan-15	7.75	Aug-16	7.25	8.50	Aug-16	0.00	10.00
Feb-15	7.50	Sep-16	7.25	8.25	Sep-16	0.00	9.75
Nov-16	8.00	Nov-16	7.25	8.50	Nov-16	0.00	10.00
source: tcmb