Extract C: Central Bank of Turkey struggles to anchor inflation expectations

The Turkish authorities implemented a series of sharp interest rate hikes in late 2023 to support the lira, after it depreciated by over 35% against the US dollar over the preceding year. This aggressive monetary tightening aimed to halt the rapid depletion of the central bank's foreign exchange reserves and prevent a full-blown balance of payments crisis. The exchange rate surpassed 28 lira to the dollar in late 2023, amid rising concerns over capital flight.

While international investors welcomed the return to orthodox monetary policy, many warned that the structural damage from prolonged periods of negative real interest rates remains deep. Independent inflation research groups estimate that annual inflation has soared past 75%, far higher than official figures suggest. In response to the cost-of-living crisis, the government has repeatedly raised the minimum wage and implemented temporary price caps on basic foodstuffs.

Turkey has long battled currency instability. Economists warn that the continuing depreciation of the lira will compound cost-push pressures, raising the price of imported energy and raw materials. This has triggered aggressive demands from public and private sector unions for inflation-indexed wage increases, leading to widespread industrial action and strikes.

These domestic pressures are exacerbated by a widening current account deficit and the central bank's historical practice of printing money to finance public sector deficits, which has severely undermined institutional credibility.