The Turkish central bank’s decision on August 24 to hike its benchmark rate by a much larger-than-expected 750bp to 25% will go a long way towards reassuring investors that the shift back to policy orthodoxy is on track, though if the move goes down badly with the president, it could lead to the firing of the new central bank governor, according to Capital Economics.

“The interest rate outlook is now even more uncertain but we think it is plausible that rates now rise far above 30% (our current year-end forecast) in the coming months,” said Liam Peach, an analyst at Capital.

He added: “Previous communications had suggested that policymakers were prioritising a gradual policy tightening in order to maintain financial stability so today’s move is a big surprise. It maintained its guidance for gradual tightening in the statement so the precise reason for the change in the pace of rate hikes is unclear. We suspect it could reflect concerns about waning investor confidence in the policy U-turn and the recent rise in US Treasury yields. The lira has reacted positively to the announcement.”

Peach said that as far as Turkey’s macroeconomic outlook is concerned this could be a game-changer, paving the way for the central bank to take rates to a much higher level and tackle Turkey’s macro imbalances. “Whether President [Recep Tayyip] Erdogan was on board with this decision is another matter and we simply can’t rule out [Turkish central bank] Governor [Hafize Gaye] Erkan being sacked as a result of this move. But at this point it’s hard not to take anything but positives away from this decision.”

Bringing inflation back to single digits in Turkey would require a prolonged period of positive real rates, perhaps with interest rates rising above 40%, said Peach, adding: “We’re still not convinced that this will happen, but peak rates above 30% (compared with our previous expectation of 25-30%) is now a much larger likelihood. If this materialises, there’s scope for a lot of the downward pressure on the lira to ease.”

Goldman Sachs said in an August 24 research note that the Turkish central bank's decision to hike rates by 750 bp was "a more forceful step" towards moving real rates to positive territory.

"We have been arguing that a clear commitment to moving real rates to positive territory is a pre-requisite for the Lira to become an attractive carry trade and today's decision is certainly a more forceful step in that direction compared to the prior gradualist approach," the investment bank said.