Ahead of Election Runoff Turkey Central Bank Leaves Rates at 8.5% as Lira Hits New Lows

The Central Bank of Turkey held its key one-week repo rate at 8.5% in its May 2023 meeting, as expected. Holding steady for a third straight month following a 50-bps cut previously in response to the country’s earthquake disaster. The lira has tumbled to record lows after President Tayyip Erdogan’s solid lead in the May 14 election became clear and Turkey’s sovereign dollar bonds and equities have plunged, while the cost of insuring exposure (CDS) to Turkish debt has spiked. Erdogan appears set to win in the runoff.

The Committee did not mention the political fallout on markets, and stuck to the mantra that they assessed that the current monetary policy stance is adequate to support the necessary recovery in the aftermath of the earthquake by maintaining price stability and financial stability. 


Since September 2021 there has been concerted pressure from President Recep Tayyip Erdogan wanting rates cut to stimulate the economy, despite a collapsed Lira and soaring inflation. The TCMB prior to the earthquake had signaled it will end the rate-cutting cycle. Turkey’s currency, the lira remained soft near a record low, with one U.S. dollar buying 18.80 lira after the announcement.

“It has become even more important to keep financial conditions supportive to preserve the growth momentum in industrial production and the positive trend in employment,” the bank said after its monthly policy meeting.

Turkey Elections

President Erdogan and his rival Kemal Kilicdaroglu face a run runoff on May 28. In the first round, Erdogan received 49.5% of the votes, while Kilicdaroglu had 44.9%, but none secured the required 50% of votes to win.

Investors were mostly betting the opposition candidate would win and reverse the unorthodox measures from the current President.

Turks can’t afford bare necessities as inflation runs rampant from the collapsed currency.

Economists expect annual inflation, which declined to 43.7% in April from a peak of 85.5% last year, to rise again in the coming months, which the highest since 1998. The surging costs are largely due to surging costs of importing energy with an increasingly weak currency.  Independent economists at ENAG, a research group that studies inflation in Turkey, say the actual rate of inflation was likely more than 185% when it was 85.5%.

They also expected the central bank to keep rates on hold this month in line with Erdogan’s unorthodox policies that call for low rates. Kilicdaroglu’s opposition alliance has also pledged to reverse Erdogan’s program with aggressive rate hikes.

The latest current account and goods trade deficits have widened sharply, no surprise but contradicting Erdogan’s pledge that Turkey would consolidate a strong surplus position.

The decision comes after 1050bps in unorthodox rate cuts since September of 2021 

Turkey Interest rates

Turkey Government 10 Year Bond Yield Rises to Four Month High

Turkey’s benchmark 10-year government bond yield traded around 9%, close to low levels not seen since January, ahead of a tight runoff on May 28th between President Erdogan and his rival Kemal Kilicdaroglu. News showed the central bank has been intervening in markets since the first round of the presidential election on May 14th to provide some stability and avoid further foreign capital outflows.

In the first round, Erdogan received 49.5% of the votes, while Kilicdaroglu had 44.9%, but none secured the required 50% of votes to win. Investors were mostly betting the opposition candidate would win and reverse the unorthodox measures from the current President.

The yield on Turkey’s 10-year government bond rose above 12.0% in late March, the highest since November, as investors weighed on the Turkish central bank’s decision to hold its key interest rate unchanged at 8.5%. Bond yields had extended their rise since the beginning of the year amid abundant debt supply as the country increased borrowing to recover from the catastrophe and stimulate growth.

Benchmark bond prices were also pressured by investors’ preference for dollar-denominated debt in the country due to the lira’s weakness. On March 9th, Turkey raised $2.25 billion in dollar-denominated debt in its first bond deal on foreign markets since January, as the government started the country’s rebuild, estimated at $100 billion.

Restrictive measures have been introduced to support the bond market, along with others that were already in place. This included discouraging banks from holding inflation-linked bonds as collateral for funding from the central bank and the encouragement of lenders to buy longer-term government bonds. The central bank of Turkey when it broke its rate-cut pause and lowered the key interest rate by 50bps to 8.5% loosened financial conditions in response to the country’s earthquake disaster.

Turkey Government Bond 10y

Turkish authorities have been introducing rules that force banks to buy government bonds. In mid-October, a mandate was set for lenders with less than half of deposits in lira next year hold an additional seven percentage points of government bonds. This regulation alone created some TRY 88 billion in demand for government bonds, and it could double for those whose lira deposits are between 50-60% of the total deposits, according to bankers.

Lira Trampled Underfoot

The lira touched a fresh record low of 19.9325 nearly an hour after the central bank decision, before recouping some losses. The Turkish central bank has also spent tens of billions of dollars in foreign currency in interventions to prevent a more severe slide in the lira, economists say.

The central bank’s net forex reserves also dropped to negative territory for the first time since 2002, standing at minus $151.3 million on May 19, in another sign of the pressure the economy faces due to the unorthodox policies.

The TCMB’s board has in the past signaled that it would continue to mandate measures to stimulate lira usage in Turkey until inflation falls to the 5% level

The Turkish government’s special savings program encourages people to keep their money in lira and introduced a rule that forces exporters to sell 40% of their foreign-currency revenue to the central bank.

Turkey is funding its unusual economic approach in part with an influx of money from Russia. Mr. Erdogan has deepened Turkey’s economic relationship with Russia this year and lately with Saudi Arabia. Turkey is boosting trade and allowing Moscow to turn to Turkey to ease the effect of Western sanctions. Erdogan turned to Russia to bolster the Turkish economy, accelerating trade between the two countries and welcoming inflows of Russian money that have helped Turkey shore up the foreign assets needed to stabilize the lira. To little affect as it heads towards USDTRY 20.

The currency is now worth about 40% of its value at the beginning of the year making imports at least doubly expensive. Turkey’s economy is heavily dependent upon imports for producing goods from basic foods to textiles, so the rise of the dollar against the lira has a direct impact on the price of consumer products.

Turkish Lira Collapse

Turkey’s current account deficit narrowed to USD 4.48 billion in March 2023 from USD 5.58 billion in the corresponding month of the previous year and compared with market expectations of USD 5.20 billion. The goods account deficit fell to USD 6.3 billion from USD 6.5 billion in the previous year, while the services account surplus increased to USD 3.1 billion from USD 2.4 billion, due to travel item which recorded a net inflow of USD 2.1 billion.

Turkey Current Account

On the other hand, the primary income gap expanded to USD 1.4 billion from USD 1.3 billion, while the secondary income swung to a surplus of USD 0.80 billion from a USD 0.19 billion shortfall. Excluding gold and energy, the current account surplus shrank to USD 1.37 billion from USD 2.46 billion in the same period last year.

Erdogan has dug his heals in from the widespread criticism and pleas to reverse course on rates. In the past two years he has sacked three central bank presidents and only this week replaced his finance minister. And so, the lira continues to collapse.

Şahap Kavcioğlu, the Turkish central bank governor, supports president Recep Tayyip Erdoğan’s theory that high interest rates cause inflation, while mainstream economists subscribe to the opposite view.

Source: TCMB WSJ

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