Erdogan Central Bank Gambit Sets Turkey Up for Shock Tightening

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Erdogan Central Bank Gambit Sets Turkey Up for Shock Tightening
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(Bloomberg) --

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President Recep Tayyip Erdogan’s stacking of the monetary policy committee has paved the way for a repeat of past missteps, when excessively low interest rates derailed the lira and forced authorities to deliver shock interest rate hikes to stave off a full-blown currency crisis.

In a move published at midnight, the Turkish leader rid the monetary authority of policy makers opposed to his calls for lower borrowing costs, setting the scene for further cuts as early as next Thursday when the bank’s rate-setting committee convenes.

Erdogan Fires Three Central Bank Interest Rate Opponents (Video)

The reshuffle pushed the currency to new lows, extending its losses this year against the dollar to over 18%, more than any other major currency tracked by Bloomberg. That will fuel consumer inflation, which is already running at nearly four times the official target of 5%.

The deteriorating inflation outlook is partly driven by the economy’s strong rebound from last year’s pandemic slump, which Erdogan wants to maintain as he tries to recover approval ratings from historic lows ahead of general elections scheduled for 2023.

But keeping the credit taps open to pump up growth in the short term usually batters the lira. In the past, that hurt companies, which in turn pressured Erdogan to abruptly reverse policy course, according to Coex Partners’ Henrik Gullberg in London.

“The only thing they can do in the end to stabilize the lira is hiking rates aggressively,” Gullberg said.

Latest Firings

Erdogan fired deputy governors Semih Tumen and Ugur Namik Kucuk, along with Monetary Policy Committee member Abdullah Yavas, after meeting with the bank’s chief Sahap Kavcioglu late Wednesday.

The two discussed changes to the committee and economic policy, people familiar with the discussion told Bloomberg. Kucuk was the only panel member to vote against last month’s surprise rate cut, they said on condition of anonymity, citing the sensitivity of the matter.

Tumen also argued against it initially, but later gave in under pressure from the governor, they said. Yavas didn’t vote because he had contracted Covid-19 in the U.S., where he lives.

The central bank declined to comment on the news.

Dissenting Voices

A self-described “enemy” of interest rates, Erdogan espouses an unconventional theory that reducing interest rates will lead to lower inflation.

He appointed Kavcioglu in March, replacing hawkish predecessor Naci Agbal after back-to-back rate hikes. Kavcioglu kept policy unchanged for nearly six months before unexpectedly cutting the benchmark rate by 100 basis points to 18% in September, when consumer inflation accelerated to 19.6%.

The last time Erdogan aggressively pushed for a quick decline in borrowing costs, then-Governor Murat Uysal began a 10-month easing cycle that slashed rates by nearly 16 percentage points to just over 8%.

Turkey spent tens of billions of dollars from its foreign currency reserves to stop a run on the lira. But eventually it was forced to appoint a new central banker and raise rates rapidly after it ran out of ammunition to meet the growing demand for dollars.

Three other governors went through similar cycles since the U.S. Federal Reserve first talked of dialing back stimulus in May 2013.

Kavcioglu champions Erdogan’s prioritizing lower rates above all else, but he surprised investors by keeping the rates he inherited from Agbal on hold until September.

Last week, Erdogan’s office denied a media report that the president was losing faith in Kavcioglu. The Turkish presidency posted a picture of the two men together on Twitter after the Wednesday meeting, and the president’s office described their conversation as “positive.”

Taha Cakmak, a deputy head of the Turkish banking regulator since 2019, was named a deputy governor With Wednesday’s decree Yusuf Tuna, a professor of economics and a member of the board at Sekerbank, was named a member of the monetary policy committee.

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