Central bank of Turkey reduces benchmark rate as domestic demand weakens

The Central Bank of Turkey reduced its benchmark interest rate on Thursday for the first time since February 2023, lowering it by 2.5 percentage points to 47.5%. 

This decision follows a period of stability, with the rate maintained at 50% since March 2023 to curb persistently high inflation, which remains above 47% year-on-year.

In a statement, the Central Bank cited a slowdown in domestic demand as a key factor influencing its decision. “Indicators from the last quarter show that domestic demand continues to decline, reaching levels that support the slowdown in inflation,” the bank explained.

This rate adjustment comes shortly after the government announced a 30% increase in the minimum wage starting January 1, raising it to 22,100 Turkish lira (approximately €600). 

While unions had pushed for a 70% increase, the government opted for what economists have described as a moderate rise.

Despite the rate cut, the Central Bank reiterated its cautious stance on monetary policy. 

“The restrictive stance of monetary policy will be maintained until a significant and lasting decline in the underlying monthly inflation trend is achieved and inflation expectations converge toward the target range,” the statement emphasized.

In November, the Central Bank raised its inflation forecast to 44% by the end of 2024, projecting a further slowdown to 14% by the end of 2025. 

This cautious optimism follows a series of sharp rate hikes earlier in the year, when the central bank raised the interest rate from 8.5% in June to 50% in March 2024 in response to inflation surging above 75% in May 2023.

Turkey’s economy has been grappling with persistent inflation, fueled by the depreciation of the Turkish lira and rising global commodity prices. 

However, inflation has been easing in recent months, with annual figures dropping to 47.1% in November, marking the sixth consecutive month of decline.

While the recent rate cut reflects optimism about managing inflation, economists warn of potential risks. Lowering rates too quickly could undermine efforts to stabilize inflation expectations, particularly if the Turkish lira remains volatile.

The Central Bank's ultimate goal is to bring inflation down to sustainable levels, with an ambitious target of 14% by the end of 2025. 

Achieving this will require balancing restrictive monetary policies with strategies to stimulate economic growth and address structural weaknesses in the Turkish economy.

Turkey’s latest monetary policy decision underscores the complexity of navigating inflationary pressures while addressing slowing domestic demand. 

The coming months will be critical in determining whether the Central Bank can strike the right balance to foster economic stability and recovery.