Turkish Eonomy Slows, Inflation Rises

T urkey's central bank is expected to maintain its benchmark interest rate for a third consecutive meeting, signaling a cautious approach as the economy slows and inflation, driven by regional conflicts, continues to rise. This decision comes despite mounting pressure from increased energy costs and recent depreciation of the lira.

A recent Bloomberg survey of 21 economists revealed that all but three anticipate the Monetary Policy Committee will keep the one-week repo rate at 37%. JPMorgan Chase & Co. stands out with a forecast for an increase to 40%, reflecting a divergence in market expectations regarding policy tightening.

Monetary Policy Amidst External Shocks

Since the onset of the Iran conflict, the central bank, under Governor Fatih Karahan, has tightened monetary policy without directly adjusting the benchmark rate. Instead, it paused lending from the 37% facility, directing banks towards the more expensive overnight rate of 40%.

This indirect tightening reflects an effort to manage liquidity and curb inflationary pressures without overtly signaling a higher primary rate. The strategy aims to control borrowing costs while maintaining a degree of flexibility in a volatile economic environment.

Lira Under Pressure

Gross foreign exchange reserves have declined by $20 billion since the beginning of the war, indicating significant capital outflows or interventions. The central bank has also reportedly sold or swapped gold holdings to mitigate further depreciation of the lira against major currencies.

As a substantial importer of oil and natural gas, Turkey faced immediate economic repercussions from the effective closure of the Strait of Hormuz. This geopolitical event led to a surge in energy prices, directly contributing to two consecutive months of accelerating annual inflation.

Inflation Outlook and Economic Growth

Despite some economists suggesting that seasonally adjusted metrics point to underlying improvements in consumer prices, the consensus outlook remains pessimistic. Most foresee annual inflation concluding the year around 30%, which is notably higher than the central bank's more optimistic projection of 26%.

Bank of America Securities economist Hande Kucuk noted that weaker-than-expected first-quarter GDP growth, coupled with subdued retail demand for foreign currency, would likely reinforce the central bank's inclination to maintain current policies. She highlighted that a clearer picture of the Iran conflict would be crucial for future reassessments.

Governor Karahan has offered mixed signals regarding the future policy direction. While he defended April's decision to hold rates by referencing a limited deterioration in the inflation outlook, he also cautioned against a prolonged divergence between the policy rate and effective funding rates. This indicates a potential for future adjustments once economic conditions stabilize or external pressures subside.