Türkiye implements a significant interest rate increase as part of a policy shift, but high inflation poses ongoing challenges.

The unexpected shift in policy by the Turkish central bank, adopting a more hawkish approach, helps restore credibility in inflation targeting. However, the rapid increase in consumer prices will challenge the commitment to the current monetary stance.

The Central Bank of the Republic of Türkiye has implemented a significant 750 basis points rise in its one-week repo rate to 25%, the largest increase since 2018 and the highest level since 2004. This move increases the likelihood of starting the disinflation process next year. It signals the commitment of Governor Hafize Gaye Erkan and the monetary policy committee to gradually adopt more conventional policies after previous decisions fell short of market expectations.

Real Interest Rates and Inflation

Despite the rate hike, real interest rates remain deeply negative as year-on-year inflation surged by nearly 10 percentage points to reach 47.8% in July. This level is nearly ten times higher than the 5% medium-term target. The central bank anticipates inflation peaking at 62% by the year-end. Both headline and core inflation are on an upward trend, driven by the depreciation of the lira against the dollar, which is impacting domestic prices.

Restoring Central Bank Credibility

Fully restoring credibility, independence, and efficiency to the Turkish central bank requires further rate hikes to reverse the current inflation trajectory. Scope Ratings forecasts the year-end policy rate to reach 33% with inflation above 60%. However, this challenge is more complex compared to previous disinflation periods, which were preceded by years of unconventional policies that caused financial distortions and altered monetary transmission channels. For instance, it took over a year from 2018 to 2019 for the central bank to reduce inflation by 17 percentage points to 10% after raising the one-week repo rate by 1600 basis points.

The Importance of Sustained Monetary Policy Tightening

The ability of the central bank to maintain a tight monetary policy in the near to medium term is crucial for Türkiye's inflation outlook and rating trajectory. On August 4, Scope affirmed Türkiye's long-term foreign-currency ratings at B- with a Negative Outlook.