Turkish central bank unexpectedly raises interest rates; lira jumps

(Story was updated with economist comment in the ninth paragraph.)

Turkey's central bank hiked its benchmark interest rate to 10.25 percent, confounding economists' expectations. The lira surged.

Monetary policymakers decided to increase borrowing costs by 200 basis points, or 2 percentage points, from 8.25 percent because of inflationary pressures, the central bank said in a statement on Thursday.

Economists had expected no change in the rate, according to polls held by Reuters and the state-run Anadolu news agency.

The lira rose 1.2 percent to 7.6 per dollar following the announcement. The battered currency had extended a record low earlier in the day partly on concerns that monetary policy was too dovish.

“The Committee considers that the continuity of the disinflation process is of great importance for the decline in the country’s risk premium, the fall in long-term interest rates and the strengthening of the recovery in the economy,” the central bank said.

Economists and investors welcomed the decision, which they said may help boost confidence in the lira. The central bank has refrained from raising the benchmark since June after President Recep Tayyip Erdoğan reiterated his opposition to higher borrowing costs.

“This is the correct move, and helps restore some of their battered credibility,” said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. “I don’t think many people expected that. They now have a chance of defending the lira.”

Still, Turkey's benchmark rate remains below consumer price inflation of 11.8 percent, meaning real interest rates are negative. The negative returns have prompted investors and deposit holders to sell the currency in search of better returns.

"Even though this may take some pressure off the FX, it's no game-changer," said Erik Meyersson, senior economist at Handelsbanken.

It was not immediately clear whether the rate hike had the approval of Erdoğan, who sacked and replaced the central bank's governor in July last year for failing to cut interest rates. Erdoğan says higher interest rates are inflationary, contradicting commonly held economic theory that rate increases can be used to curb inflation.

Investors say that the central bank has been too slow to act and raise rates when the lira has come under selling pressure. It delayed such a move in 2018, when lira weakness turned into a currency crisis.