Turkey's Central Bank maintains 8.5% policy rate ahead of election runoff

In a move widely expected by economists, Turkey's central bank decided to keep its policy rate steady at 8.5% on Thursday, marking the third consecutive month without a change. This decision comes despite a turbulent market following the first round of presidential elections, in a sign of expectancy for the markets that President Tayyip Erdogan was on track to win in the runoff.

Since Erdogan's solid lead in the May 14 vote became evident, the Turkish lira has experienced a sharp decline, reaching record lows. Consequently, Turkey's sovereign dollar bonds and equities have also plummeted, while the cost of insuring exposure to Turkish debt has surged.

However, the central bank made no mention of these market movements but emphasized that the underlying trend of inflation has been improving in its announcement on Thursday.

"It has become even more important to keep financial conditions supportive to preserve the growth momentum in industrial production and the positive trend in employment," the central bank said, following its monthly policy meeting.

While economists anticipate a rise in annual inflation in the coming months, which declined to 43.7% in April from a peak of 85.5% last year, they expected the central bank to maintain interest rates this month in line with Erdogan's unconventional policies calling for low rates.

Nicholas Farr, an emerging Europe economist at Capital Economics, expressed concern about the expected victory of President Erdogan, stating that the likelihood of "much-needed" rate hikes is low.

Speaking to Reuters, Farr said, "Turkey's economy is in desperate need of much higher interest rates and a shift away from the current policy framework to tackle its large macro-imbalances."

Farr warned that if Erdogan wins, the authorities can only employ "distortionary policies" for a limited time to stabilize the lira, and a significant depreciation in the currency is inevitable.

The Turkish lira reached a new record low of 19.9325 shortly after the central bank's decision before recovering some losses.

Additionally, the central bank's net forex reserves fell into negative territory for the first time since 2002, standing at minus $151.3 million on May 19. This decline highlights the pressure on the Turkish economy resulting from the unorthodox policies pursued.

For years, authorities have implemented market interventions and other measures to curb forex demand. However, the recent drop occurred as forex demand surged in anticipation of a lira devaluation after the election.