Turkey Keeps Rates Unchanged Even as Lira Plumbs Record Low -- Update

By David Gauthier-Villars and Caitlin Ostroff

ISTANBUL -- The Turkish central bank kept its benchmark interest rate unchanged Thursday, in line with President Recep Tayyip Erdogan's demand to keep it low, but leaving the emerging economy exposed to further capital flight and a potential currency crisis similar to the selloff that beset Turkey two years ago.

The central bank left its key, one-week repo rate at 8.25% for a third consecutive month, but it has begun tightening the money supply by channeling borrowers through some of its other lending facilities that carry higher rates.

Economists say the approach, under which the central bank can push up its average effective policy rate to about 11.5%, is seemingly designed to avoid provoking Mr. Erdogan. The president fired a central bank governor who balked at cutting interest rates last year. But it might not be sufficient to mop up an excess supply of Turkish lira that hammered the currency to all-time lows against the U.S. dollar this month.

Even factoring in the "backdoor" hike, economists warned the central bank's average lending rate remains negative when adjusted for inflation, which stood at 11.8% in July, heightening selling pressure on the lira. Holding assets denominated in Turkish currency is becoming a riskier proposition.

The situation resembles the summer of 2018, when the central bank let its main interest rate slip below the rate of inflation and the lira crashed to a record low. The currency subsequently stabilized and regained some strength, but only after the central bank increased its benchmark rate to 24%.

"It looks like another sort of déjà vu of 2018," said Viraj Patel, a foreign-exchange and global rates strategist at research firm Arkera. "They haven't learned from their lesson."

The central bank has said all its decisions were free of political interference.

The multiple-rate framework was introduced in 2012 to give the Turkish central bank the ability to fine-tune its policy without resorting to emergency meetings that might have caused panic at a time of great volatility on foreign-exchange markets, according to Durmus Yilmaz, a former central bank governor. More recently it has been used to tighten money supply without touching the benchmark rate and keep politicians happy, he said.

"The present architecture is not effective in conveying the right signals," Mr. Yilmaz said. "It's high time the central bank changed and simplified monetary policy design."

--Pat Minczeski contributed to this article.

Write to David Gauthier-Villars at [e-mail] and Caitlin Ostroff at [e-mail]