Turkey’s central bank decided to keep all of its three main interest rates unchanged at a meeting on December 20, defying market expectations and sending the lira down to reverse daily gains. Analysts, however, suggest the bank will likely resume its tightening cycle in 2017.

The bank kept the one-week repo rate at 8%, the overnight lending rate at 8.5% and the overnight borrowing rate at 7.25%​. Economists were expecting the bank to follow up last month’s 25bps hike in the overnight lending rate with a further 25bps hike to shore up the lira that has lost more than 20% of its value against the US dollar this year so far. Analysts were also expecting a hike in the upper band of the interest rate corridor (overnight lending rate).

The lira reversed earlier daily gains, falling 0.7% against the US dollar to trade at 3.5386 following the rate decision. The main stock exchange index, BIST-100, fell 0.5%.

“But today’s decision is only likely to be a pause in the tightening cycle and we expect substantial interest rate hikes next year,” analysts at Capital Economics wrote in a note. The recent stabilisation of the lira against the dollar, and comments from President Erdogan arguing against higher interest rates, probably played a role too, according to the analysts.

Capital Economics expects the tightening cycle to continue next year, pencilling in 150bps of hikes in the overnight lending rate, to 10.00%, by the end of next year. “For one thing, the economy should return to positive growth as the impact from July’s coup attempt fades. More importantly, the lira is likely to come under renewed pressure next year as the US Fed raises interest rates – we expect the currency to fall to 3.75/$ by the end of 2017 (from 3.53/$ now),” they said.

“Exchange rate movements due to recently heightened global uncertainty and the increase in oil prices pose upside risks on the inflation outlook. Yet, the aggregate demand developments restrain these effects,” the bank said in a statement released following the monetary policy committee meeting on December 20. “Developments will be closely monitored in order to make a sound assessment regarding the net impact of these factors.”

The bank reiterated that future monetary policy decisions will be conditional on the inflation outlook. “Inflation expectations, pricing behaviour and other factors affecting inflation will be closely monitored and the cautious monetary policy stance will be maintained.”

The statement suggests that the central bank it is in a wait and see mode to measure the effects of the US Federal Reserve’s policies and other global developments. Turkey’s GDP contracted by 1.8% in the third quarter of 2016, marking the first decline in national income in seven years.

“Recently released data indicate that the economic activity has decelerated in the third quarter, before posting a partial recovery for the final quarter. With the supportive measures and incentives provided recently, the recovery in the economic activity is expected to continue at a moderate pace,” the bank said in the statement.

President Recep Tayyip Erdogan has been calling for cheaper credit to boost economic activity. Investors probably take some comfort from the fact that the bank at least did not cut the rate at this stage to support investments and domestic consumption. Following a sharp reaction to the bank’s rate decision, the lira gained some ground and stocks rose. The lira was trading at 3.5217 per dollar as of 15:00 Istanbul time.

Some analysts also said the statements regarding the Syria conflict also supported the lira. Russia, Iran and Turkey have started the process of finding a political solution to the conflict in Syria, Iran's Foreign Minister Mohammad Javad Zarif said at a meeting of the three countries' foreign ministers in Moscow on December 20, Reuters reported.