Turkey’s president, Recep Tayyip Erdogan, on December 16 piled on the pain for Turks suffering from the collapse of the Turkish lira with another rate cut before offering some relief with the announcement that the minimum wage would be lifted by 50% to maintain its US dollar value.

Analysts, however, were quick to serve warning that the minimum wage increase to Turkish lira (TRY) 4,250 ($271) from 2022 would further drive up rampant inflation. Marek Drimal at Societe Generale, for instance, said it would “fuel inflation pressures further, together with the cumulative impact of the lira’s weakness”.

The dollar value of the 2021 minimum wage of TRY 2,825 per month has sunk to $185 from $380 since the start of the year in line with the halving of the value of the lira. And there are fears that hyperinflation has set in in Turkey. Though official inflation is running at 21%, independent analysis led by Turkish academics at ENAG calculates that it has reached at least 60% and continues to shoot up.

Usual defiant self

Erdogan, widely seen as running Turkey’s monetary policy from the palace, was his usual defiant self after waving through a 100 bp cut—to add to 400 bp of cuts made since September—in the central bank’s policy rate to 14%, announcing the improved minimum wage and promising unspecified measures to ensure lira stability in the coming days. The latest rate cut in the face of surging inflation sent the TRY to yet another all-time low against the USD—it fell towards 6% to TRY 15.748—but Erdogan vowed to take on the currency markets, decrying that Turkey’s destiny would not be determined by the level of borrowing costs or by foreign exchange speculators.

He also declared: "With this increase [in the minimum wage], I believe that we have demonstrated our determination to protect our employees from being crushed in the face of price increases."

The government, added Erdogan, would also lift taxes on the minimum wage to ease burdens on employers.

Erdogan has asserted that he is fighting an “economic war of independence” to boost domestic industry and ensure Turkey cannot be bashed by the global markets, but the country is hugely reliant on foreign capital, thus analysts generally see him as pursuing a crazy economic experiment, bidding to build short-term popularity with a credit-fuelled economy ahead of elections that must be held by June 2023. The central bank has signalled that it may now pause monetary easing until at least the second quarter of next year but with the mercurial strongman in charge no-one can really know where policy goes from here.

'Expected, but still unbelievable'

Ahead of the rate cut, the markets were crying out for a change of course, but were resigned to the latest decrease being pursued nonetheless. The rate cut was "as expected, but still unbelievable," John Hardy, head of FX strategy at Saxo Bank, commented.

The day also saw the central bank announce that inflation expectations for the next 12 months have surged to 21.39% from 15.61%, according to its December survey of market participants.

Analysts will now watch for the prospect of capital controls being brought in if the lira crisis deepens from here.

Jason Tuvey at Capital Economics said: "Today's move provides further evidence, if any were needed, that macro developments are playing little role in the CBRT's [Central Bank of the Republic of Turkey’s] policy formulation.”

He added: "The accompanying statement [from the CBRT] suggests that the easing cycle will be on pause early next year but, even so, the lira will remain under pressure and capital controls are likely."

Jakob Christensen at Danske Bank commented: “We expect that even though they are now staying on hold, the fact that inflation will be peaking further, and that the U.S. central bank is in a tightening mode, there's a bias towards a weaker lira.

"I am concerned about the inflation outlook in the next two to three months, as the sharp weakening in the lira feeds through... inflation will definitely go above 30%."

'Tolerance for lira pain'

At Scope Ratings, Dennis Shen, noted that "the central bank's tolerance for lira pain certainly appears much higher this go around with Erdogan now more or less fully in charge of rates policy.

"The only thing is that even if destabilising lira devaluation is somehow being fully justified away as being good for correction of the current account and raising exports, now that the lira crisis is starting to have an effect on dampening growth conditions—whether such weakening economic growth might force Erdogan to change course ahead of elections by 2023?

"If so, any 'change of course', however, may not mean a rate hike immediately even if the central bank pauses rate cuts at least over the near future, instead potentially meaning capital controls, more FX swaps with domestic banks and friendly allies, and use of reserves to support lira should lira sell-off pressures continue."

Ipek Ozkardeskaya at SwissQuote Bank, said he now expected the USD/TRY to end the year within the 17-19 band.

Haluuk Burumcekci at Burumcekci Consulting said in a note: "[The central bank] at least giving the signal that it won't lower interest rates until March is a limited positive development for the Turkish lira... The central bank will most likely try and navigate this period by using macroprudential tools, primarily required reserves, and by resorting to direct forex sales in the market at times. In other words, without raising interest rates."

He added: "Considering inflation in Turkey will rise to 35% and more mid-next year due to the recent lira outlook, the possible minimum wage hike, significantly deteriorating inflation expectations and the global inflation backdrop we think these measures will not be enough and the bank will have to raise the policy rate in the not-so-distant future."