Turkey holds rates in favour of back-door steps to support lira

ISTANBUL: Turkey's central bank held its benchmark interest rate steady as expected on Thursday despite the lira hitting record lows this week, and it paved the way to more back-door measures that have tightened credit and slowed the currency's decline.

The bank said exchange rate moves have delayed an expected drop in inflation, as it kept its one-week repo rate unchanged at 8.25%. It has held policy steady since June following an aggressive year-long easing cycle.

Analysts said a formal tightening of monetary policy may have only been delayed given looming concerns over depleted central bank reserves, costly state interventions in the currency market and Turks' surging demand for hard currencies.

The central bank said upward pressure on inflation will eventually "phase out" along with the impact of the novel coronavirus. Yet it acknowledged that "exchange rate and credit developments restrain the demand-side disinflationary effects," raising inflation trends.

It will continue with "liquidity measures," the bank added.

The policy rate is sharply below annual inflation at 11.76%. But economists said the back-door measures and political pressure would likely keep the bank on hold, and only five out of 17 in a Reuters poll had expected a hike.

The lira slid 0.9% to 7.347 versus the dollar in response, and is down 19% this year. The currency hovered around 6.85 for two months before a burst of selling in late July raised some expectations for a policy pivot.

"Back-door rate increases...do not do enough to assuage markets that a credible monetary policy response is in force," said Dennis Shen, director of public finance at Scope Ratings.

"Absent such a permanent and credible rate hike, pressure on the lira will likely remain in the backdrop," he said.

The central bank has used other tools to raise borrowing costs, which have lifted the weighted average cost of funding to 9.37% from a low of 7.34% on July 16.

The latest such move came on Thursday when the bank separately raised forex and lira required reserve ratios for commercial lenders.

The lira had recovered some ground on Wednesday after President Tayyip Erdogan told energy executives that he would share "good news" on Friday - comments which one source said referred to an energy find in the Black Sea.

Erdogan has long held the unorthodox view that high interest rates cause inflation, and last year he sacked the previous central bank governor for not following instructions.