Turkey’s central bank surprises markets with a drastic interest rate cut as inflation eases

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The decision comes amid a continued decline in inflation: the annual consumer price index (CPI) fell to 47.09% in November, the lowest level since June 2023. This represents the sixth consecutive month in which inflation has declined, compared with 48.58% in October. On a monthly basis, inflation rose 2.24%, the smallest increase in five months.

The disinflationary dynamic is increasing in Turkey

The CBRT stated that “leading indicators point to a decline in the underlying trend in December,” with domestic demand continuing to weaken. While inflation in core goods remains subdued, prices in the services sector are showing signs of improvement. Previously elevated unprocessed food inflation appears to have eased in December.

The central bank noted that restrictive monetary policy promotes disinflation by weakening domestic demand, encouraging real appreciation of the Turkish lira and raising inflation expectations.

However, it warned that inflation risks remained and pledged to maintain a prudent monetary policy approach and adjust its stance from meeting to meeting.

Looking ahead, the CBRT reiterated its medium-term inflation target of 5% with a tolerance band of 2%, while forecasting inflation to fall to 21% by the end of 2025 and 12% by the end of 2026.

“We believe the new forecasts are now more achievable, but the projected delay in the inflation process is likely to attract some attention,” Muhammet Merkan, an economist at ING Group, said recently.

Improved credit rating and economic prospects

Turkey’s recent economic stabilization efforts have received international recognition. In November, Standard & Poor’s upgraded Turkey’s long-term credit rating to BB- from B+, citing improved monetary policy, stabilization of the lira and rebuilding of foreign reserves.

The agency highlighted the narrowing current account deficit, which has fallen by around four percentage points of gross domestic product since 2022, as a positive signal.

Similarly, a recent report from BBVA praised the CBRT’s accumulation of foreign exchange reserves, noting the bank’s return to being a net buyer of foreign exchange.

Despite these successes, challenges remain. The Organization for Economic Co-operation and Development (OECD) forecasts Turkey’s GDP growth to slow to 3.5% in 2024 and 2.6% in 2025, reflecting the impact of necessary macroeconomic stabilization measures.

Market reactions

The Turkish lira remained stable after the interest rate cut decision, the euro-lira exchange rate remained stable at 36.61.

Since November, the lira has risen 2% against the euro, but has weakened by 12% against the single currency over the course of 2024.

As Turkey moves towards sustainable disinflation and economic rebalancing, the CBRT’s strategy of maintaining tight monetary policy while promoting coordination with fiscal measures will be critical to achieving long-term stability.