The Turkish central bank’s monetary policy committee (MPC) on July 10 hiked its policy rate by 250bp to 17.50% (chart), the MPC announced in a statement.

The market expectation was for a 500bp rate hike. In June, the MPC launched the ongoing tightening process by hiking the policy rate by 650bp to 15% from 8.50%. That move also undershot the market prediction.

The next MPC meeting is scheduled for August 24. As things stand, another 250bp hike appears to be on the way.

Recent indicators point to a continuation of the increase in the underlying trend of inflation, the statement from the MPC said.

The evident strong course of domestic demand, cost pressures stemming from wage hikes and exchange rates and the stickiness of services inflation have been the main drivers in Turkey’s recent inflation trends.

The MPC said it also anticipated that tax regulations and a deterioration in pricing behaviour would put further pressure on inflation.

Monetary tightening will be further strengthened as much as required in a timely and gradual manner until a significant improvement in the inflation outlook is achieved, according to the MPC.

The committee is also set to continue a gradual approach to simplifying and improving the existing micro- and macroprudential frameworks.

In this context, the MPC has taken decisions on quantitative tightening and selective credit tightening to support the monetary policy stance.

Turkey’s policy rate still remains idle on the sidelines, meaning monetary policy is conducted via macroprudential measures and non-capital controls.

For June, the Turkish Statistical Institute (TUIK, or TurkStat) released official consumer price index (CPI) inflation at 38% y/y.

On May 4, the central bank left its expectation for end-2023 official inflation unchanged at 22% (upper boundary: 27%).

The guidance was based on the assumption that the Turkish lira (TRY) will not experience another crash. As of July 20, the USD/TRY rate in the interbank market was up by 38% to TRY26.88 from TRY19.49 on May 4. The latest record high of TRY27.22 was registered on July 19.

TRY28 and TRY30 are viewed as the upcoming levels on the USD/TRY chart.

Despite the Erdogan regime’s latest retreat into economic orthodoxy, Turkey’s FX market is still not free. Officials are still controlling the interbank market via government-run banks. However, the interventions are at a lower level than the FX inflows into the central bank’s balance sheet. Exporters are still obliged to sell up to 70% of their FX revenues to the central bank.

Since the central bank is currently a net FX buyer in the market, meaning it is providing central bank money to the system in exchange for FX, its net lira funding has turned negative. That means the banks are parking their extra central bank money with the authority.

The MPC pointed to this issue in its rates statement. It said it would deliver more macroprudential measures to absorb the excess lira liquidity in the system. The prevailing speculation is that the central bank will introduce a required reserve mechanism on the FX-protected “KKM” deposit accounts.

Amid the booming lira supply and hard currency outflows via significant trade deficits, Turkish officials manage to keep a slippery grip on the lira by strong-arming bankers into blocking (achieved with non-capital controls) and suppressing (achieved with macroprudential measures) domestic FX demand. Also supportive are unidentified inflows and other assistance from “friendly countries”.

This week, Turkey’s president, Recep Tayyip Erdogan, visited Saudi Arabia, Qatar and the UAE. Tens of billions of dollars in soft investment pledges made to Turkey were reported by the media. However, the exact amounts, precise investments and timings of the inflows were, as per usual, not provided.

The Turks, meanwhile, terrified of the lira plunging even further, have been piling up cryptocurrency, cars and gold in addition to hard currencies.

The KKM FX-protected deposits scheme rose from TRY 2.63 trillion as of June 16 to TRY 2.96 trillion as of July 14 while the USD-denominated amount rose from $112bn to $114bn.

As of July 14, the KKM accounts for 24% of total deposits while the share of FX-linked deposits stands at 43%. Overall dollarisation stands at 67%.

On July 27, new central bank governor Hafize Gaye Erkan will release her first inflation report and the central bank’s updated inflation forecasts.

Recently, the government has delivered historical tax hikes along with fee and salary hikes. The fiscal tightening led by new finance minister Mehmet Simsek is proceeding on a more “front-loaded” track rather than “gradual”.

The government may have decided to tighten its grip by the end of 2023 and deliver relief in the new year, prior to the local elections to be held in March.

With an omnibus bill that became effective on July 15, the special consumption tax (OTV/SCT) on fuel products will be automatically hiked every six months with official domestic producer price index (PPI) inflation. VAT levied on fuels was raised to 20% from 18%.

The omnibus bill also provided Erdogan with the authority to hike OTVs by up to fivefold. The OTVs are fixed sums.

On July 16, a big hit to fuel prices arrived. Erdogan delivered a historical hike in the OTV on fuel products. He tripled the OTV on fuel products. For instance, the OTV on 95-octane gasoline was hiked to TRY 7.53 from TRY 2.53. A 20% VAT rate is applied to this sum.

As the historical tax hikes added to lira depreciation, fuel prices broke records. Gasoline prices in Turkey have risen by 76% since the beginning of May to TRY 34 per litre as of July 18. Diesel prices were up 80% to TRY 32.

Chart: Fuel prices in Turkey.

Also on July 16, Erdogan tripled the OTV on natural gas to TRY 0.0747 per cubic metre (m3) from TRY 0.023. A 20% VAT rate is applied to this sum.

Separately, the omnibus bill  doubled the motor vehicle tax to be paid in 2023.

Effective as of July, Erdogan brought in hiked VAT rates. The VAT rate that was applied as 8% on certain products was pushed up to 10%, while the VAT rate applied as 18% to other products was doubled to 20%. The VAT rate on hygiene products, cut to 8% during the COVID-19 pandemic, was increased to 20%. The VAT on electronic products was moved up to 20% from 18%. VAT charged on medicines was hiked to 10%.

On July 13, the treasury and finance ministry hiked official document fees by 50%.

On July 19, the ceiling price that airlines can charge for a one-way ticket on a domestic route in Turkey was raised by 43% to TRY 1,650 ($62).

Earlier this month, Izmir Water and Sewerage Administration (IZSU), the water utility management unit of Izmir Municipality, hiked the cubic-metre (m3) price of the water utility service by 43%, effective as of August.

Across the month, the bread prices in various provinces have also been hiked. In Rize province, the bread price was hiked by 42% to TRY 8.5 from TRY 6, the price set in a January increase from TRY 5.

In Kocaeli, Adana and Osmaniye provinces, the bread price was hiked by 50% to TRY 7.5 from TRY 5. In Ankara, the bread price was hiked by 40% to TRY 7 from TRY 5.

In Ankara, the public transport ticket price was raised by 42% to TRY 15 from TRY 9.5. In Antalya, the public transport ticket price was pushed up to TRY 15 from TRY 9.60.

Intercity bus ticket prices were hiked by 40%.

On July 14, tea product prices were increased by 10% on average. In June, the prices were raised by 43% on average.

On August 3, the TUIK will release the official inflation figure for July.

In parallel with the tightening process, weighted average interest rates on lira loans and deposits have recently been rising while loan growth has been curbed.

As the lira has lately been allowed to depreciate, the central bank’s net FX reserves rose to $13bn as of July 14 from $9bn as of June 23 after turning to a positive $0.5bn as of June 16. A record low was registered at minus $6bn on June 2.

The gross reserves rose from $103bn as of June 16 to $113bn as of July 14. The figure stood at $130bn as of February 3 and at $98bn as of May 26.

The recovery in the reserves does not mean that the central bank has removed its control of the FX market. It has eventuated because the inflows (rediscount credits, export revenues and so forth) are bigger than FX sales via public banks.

Sentiment on the global markets remains turbulence-free. Turkey’s five-year credit default swaps (CDS) have fallen below the 500 level, while the yield on the Turkish government’s 10-year eurobonds has fallen below the 9% level.

On May 24, unnamed sources told Bloomberg that Turkey’s central bank asked some local lenders to buy the country’s dollar bonds to prevent a CDS spike.