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Turkey expects drastic interest rate hike to fight inflation and stabilize lira amid economic crisis

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Turkey is widely expected to back away Thursday from President Recep Tayyip Erdoğan’s years-long unconventional economic policy and drastically raise interest rates to fight inflation and stabilize the battered lira, Agence France-Presse reported.

Erdoğan continues to defend his idea, which runs counter to the markets, that high interest rates are contributing to the rising consumer prices that have doomed Turkey over the past five years, rather than curing them.

However, the central bank is expected to change course and double or even triple the current key interest rate in its first meeting since Erdoğan filled his government with investor-backed faces after a narrow election victory in May.

Turkey’s leader urged the central bank two years ago to cut interest rates as part of a “new economic model” focused on job creation and economic growth.

This policy thoroughly backfired.

Annual inflation reached 85 percent late last year and the central bank burned through much of its reserves in an attempt to keep the lira — which has fallen 90 percent against the dollar in the past 10 years — from an even bigger crash.

Erdoğan was forced into his first runoff election and then made one of his typical political U-turns after extending his two-decade rule until 2028.

He appointed respected economist Mehmet Şimşek as finance minister and former Goldman Sachs director Hafize Gaye Erkan as head of the nominally independent central bank.

Turkish media reported that Şimşek agreed to join the government only after being assured that he could steer the ship as he saw fit.

Turkey had “no choice but to return to the ground of reason,” Simsek said after taking office.

Erdoğan said last week that he had “accepted” that his new team would pursue policies contrary to his own firm convictions.

How high?

Şimşek’s presence has already had an impact.

The lira has lost another 15 percent against the dollar since the May 28 runoff election — a sign that the central bank is slowly scaling back its costly currency defense.

Before one of the central bank’s most high-profile meetings in years, a dollar was worth about 23.55 lira.

Analysts are divided, however, on how far and how fast Turkey will raise its key interest rate from the current 8.5 percent.

Clemens Grafe, an economist at Goldman Sachs, said that “an orthodox policymaker would raise rates to 40 percent, the current level of deposit rates.”

JPMorgan and Bank of America both predicted a hike to 25 percent.

Capital Economics, however, said “there are grounds for caution” as the new team showed signs of favoring a slower approach.

“Indeed, the lira’s depreciation already appears to have stalled,” the London-based consultancy said.

Şimşek and newly appointed Vice President Cevdet Yılmaz — a technocrat who is also admired by investors — flew to petrodollar-rich Abu Dhabi on Thursday to solicit new investment and loans.

Borrowed time

Foreign investors, who had initially cheered Erdoğan’s new appointments, are now worried about how long the Turkish leader’s patience with his new team will last.

Many point to the dismal experience of Naci Ağbal — a market-friendly central banker whom Erdoğan fired four months after his attempts to raise interest rates in late 2020 and early 2021.

Some analysts are encouraging the new team to act quickly and then brace for the potential political fallout.

Others say Turkey’s economic problems are too complex to tackle simultaneously.

One of Turkey’s most costly programs is the bank deposit guarantee system that Erdoğan introduced at the end of 2021.

It obliges the government to compensate for any losses that lira deposits suffer as a result of the currency’s devaluation against the dollar.

This means that a quick return to a floating exchange rate could put even more strain on the strained budget.

Many expect Şimşek to phase out the regime.

Erdoğan said Wednesday he was putting his faith in his new appointments.

“We have given a very big responsibility to our economic management. We have assembled a strong, harmonious and competent team,” he said.

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