Turkey Delivers Smallest Rate Cut Yet as Lira Storm Builds

(Bloomberg) — Turkey’s central bank cut interest rates again, delivering the smallest decrease of its seven-month easing cycle but still risking a market backlash as investor tolerance of lower borrowing costs starts to wane.

The Monetary Policy Committee reduced its key rate for a sixth straight time on Wednesday to 10.75% from 11.25%. While most analysts surveyed by Bloomberg predicted a cut, expectations ranged widely. The median forecast was for a reduction of half a percentage point, and a sizable minority predicted a hold.

The MPC left its guidance unchanged while adding a word of caution on Turkey’s lending boom. It also removed a mention of an improving outlook for inflation.

“Developments in credit growth and its composition are closely monitored for their impact on the external balance and inflation,” it said in a statement. “The central bank will continue to use all available instruments in the pursuit of price stability and financial stability objectives.”

Looking past market unease, Governor Murat Uysal is pushing Turkey’s inflation-adjusted rates further below zero at a time price pressures are intensifying. After weathering 13.25 percentage points of easing since July, the lira has grown more volatile and Turkey’s geopolitical entanglements are unsettling nerves among investors.

The latest move brings Turkey’s real rate to minus 1.4%, below such developed countries as the U.S., the U.K., Japan and Canada. Turkey’s currency has lost more than 3% against the dollar over the past month. It erased an earlier gain after the rate announcement and traded 0.3% weaker at 2:24 p.m. in Istanbul.

Rattled by the drop in the lira, Turkish authorities have made it more difficult for foreign investors to bet against the currency by cutting the amount of foreign-exchange swaps and derivatives deals that banks can carry out with non-residents. State banks have also been making a stand by flooding the market with dollars.

Interrupting the easing cycle carried risks for Uysal, whose predecessor was fired by President Recep Tayyip Erdogan for not reducing rates fast enough. Contrary to the thinking of most economists and central banks, Erdogan believes lower borrowing costs are more effective at slowing prices and has repeatedly said that rates will drop into single digits this year.

“Despite interest rates falling, the exchange rate didn’t explode, inflation didn’t jump, markets didn’t get stirred up, nor was any other difficulty experienced,” state-run Anadolu Agency cited Erdogan as telling lawmakers last week.

Meanwhile, inflation accelerated faster than forecast for a second month, reaching 12.2% in January. The central bank expects price growth to stay elevated in the first quarter at around 11.5% before it starts decelerating and drops to single digits from the second half.

Uysal said the central bank expects to offer investors a positive real rate of return when taking the projected path of inflation into account. Its current forecast is for consumer price growth to slow to 8.2% by year-end.

(Updates with central bank comments starting in third paragraph)