Chart showing Turkey's currency problems, Turkish lira versus the dollar (TL per US dollar)

Investors welcome a change of course as Turkey presents a sharp rise in interest rates

Turkey announced its biggest rate hike in more than two years when it signaled a change of direction after a drastic shift in the country’s economic management.

In the first interest rate setting meeting, chaired by the new central bank governor Naci Agbal, the bank attempted to tame double-digit inflation and bolster the Turkish lira by increasing its weekly reference repo rate by 4.75 percentage points to 15 Percent increased.

The lira rose nearly 3 percent against the dollar immediately after the decision, before reducing its gains to 1.9 percent, or TL 7.56. The Turkish currency is still down 22 percent since the end of last year.

The lira suffered record lows for months before President Recep Tayyip Erdogan’s son-in-law Berat Albayrak resigned as finance minister 10 days ago. Investors were increasingly alarmed about the economic management under the 42-year-old’s watch, particularly the apparent reluctance to fight inflation or halt the currency’s downward spiral and the erosion of the country’s foreign exchange reserves.

Thursday’s decision was seen by many investors as evidence that Mr Erdogan, a staunch opponent of high interest rates, had mandated the new governor to act – at least in the short term – to stabilize the currency and a much-needed wave of overseas Capital back into the Turkish markets.

[The increase] doesn’t seem like much. . . However, investors increasingly focused on whether the decision would mean a shift towards orthodox policy making

Ehsan Khoman, head of research and strategy for the Middle East and North Africa at Japanese bank MUFG, said the central bank had to “inspire the markets, restore credibility and predictability” and did “just that”.

Yerlan Syzdykov, global head of emerging markets at asset manager Amundi, described the decision as “clearly a good result”.

The rate hike, which was in line with the expectations of the economists surveyed by Bloomberg, means that the one-week repo rate is slightly higher than the average interest rate the central bank has been charging for funding the Turkish financial system in recent weeks.

It had used an intricate, multi-rate system apparently aimed at tightening monetary terms without incurring the president’s ire, and increased the bank’s effective funding cost to 14.8 percent by Wednesday.

An announcement by the bank that it will provide all of the financing via the one-week repo rate means that following Thursday’s decision, the actual increase in the interest rate it charges will be just 0.2 percentage points.

However, the move was welcomed by investors and analysts as a sign that the bank was returning to a more conventional approach to monetary policy.

The increase “doesn’t seem like much, given what was at stake,” said Jason Tuvey, a leading emerging market economist with Capital Economics, the consulting firm. “However, investors were increasingly focused on whether the decision would mean a shift towards orthodox policymaking – that is, a transparent monetary policy framework based on a key rate.”

Turkey was stunned by the shock resignation earlier this month of Mr Albayrak, who wielded significant power across the government and was widely viewed as the political heir chosen by Mr Erdogan.

The former chief executive, who is married to the president’s daughter, Esra, resigned after public discontent with the economy increased and urged his father-in-law to fire the then central bank governor Murat Uysal. His successor, Mr Agbal, was known to criticize Mr Albayrak’s approach.

Investors, many of whom are desperate for returns, at a time when the global pile of negative-interest debt is at a record high, have welcomed the decision to appoint Lutfi Elvan, a market-friendly ex-bureaucrat, as the new Treasury Secretary and a commitment from Mr. Erdogan last week that Turkey would “swallow a bitter pill” if necessary to get the economy back on track.

Mr Syzdykov, who oversees the $ 14.6 billion fund, said Amundi had increased its exposure to Turkey in a number of asset classes following Mr Albayrak’s departure. “It is a very important step for Erdogan. I think it shows that he can be flexible, ”he said.

“Of course Erdogan’s tendency to intervene will not go away. I just think that he now realizes the gravity of the situation with the economy. “

Wolfango Piccoli, co-president of consulting firm Teneo Intelligence, was more cautious. He said the record of Mr. Erdogan, who is notorious for meddling with the central bank, could quickly “revert to his standard level, pumping credit ahead of schedule, accelerating inflation and depressing inflation [lira] once again”.

The road to economic recovery is tight, he added, especially given the coronavirus crisis and the fact that Mr Erdogan has repeatedly ruled out the prospect of turning to the IMF for help.

Additional coverage from Adam Samson in London