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Turkey central bank in huge rates hike to stop lira rot

Turkey's central bank on Tuesday aggressively raised its key interest rates Tuesday, in a dramatic move to stem a steep drop in the country's lira currency.

ANKARA: Turkey's central bank on Tuesday aggressively raised its key interest rates Tuesday, in a dramatic move to stem a steep drop in the country's lira currency.

The lira perked up after the shock decision, which comes amid the Turkish regime's most damaging political crisis in a decade and went against Prime Minister Recep Tayyip Erdogan's recommendation.

The central bank hiked its overnight lending rate to 12 per cent from 7.75 per cent, the overnight borrowing rate from 3.5 per cent to 8 per cent, and one-week repo rate to 10 per cent from 4.5 per cent.

The lira strengthened after the crisis meeting to 2.17 against the dollar from 2.25 before the announcement.

"Recent domestic and external developments are having an adverse impact on risk perceptions, leading to a significant depreciation in the Turkish lira and a pronounced increase in the risk premium," the bank said in a statement posted on its website at midnight.

"The central Bank will implement necessary measures at its disposal to contain the negative impact of these developments on inflation and macroeconomic stability," it added.

The bank said it decided to implement a "strong monetary tightening and to simplify the operational framework".

Analysts said the decision was a "turning point" that went "beyond expectations".

They said the decision would bring fresh credibility to the bank after months of inaction raised questions about its independence from Erdogan.

The central bank "left nobody in doubt on Tuesday night when they hiked interest rates," Gillian Edgeworth, economist at UniCredit Research, said in a statement.

"Following the turmoil of the past few weeks, tonight's meeting probably had to deliver two things in order to stabilise Turkish financial markets," Neil Shearing, chief emerging markets economist at the London-based Capital Economics, said in a statement.

"First, it had to deliver a substantial tightening of policy. And second, the policy tightening had to be delivered in a clear and transparent way ... On both counts, tonight's meeting delivered about as much as could reasonably have been expected".

Early Tuesday, the bank hinted at interest rate hikes, saying that it was ready to tighten monetary policy in a "lasting way".

"Nobody should have any hesitation that the central bank will use all available tools," the bank's governor Erdem Basci told a press conference.

But Erdogan's reiteration before what observers had billed as make-or-break meeting of his opposition to a hike had left some doubt as to whether decisive action would be taken.

"I am opposed to interest rate increases now as I always have been," Erdogan told reporters at an Ankara airport before leaving for Iran.

"But I don't have any authority to interfere in the central bank," he said, adding that he hoped the bank would make a "right decision".

Erdogan's government wants rates held down to sustain growth ahead of an election cycle beginning with March local polls.

Until now, the bank has avoided a sharp rise in the base rate, using a big increase in the overnight rate -- held at 7.75 per cent last week -- and intervening heavily on the foreign exchange market.

Some analysts estimated in July last year, when the bank began intervention, that it had about $46 billion dollars (34 billion euros) available but since then it has spent heavily, using up to $4 billion in the last few days alone.

And those costly measures have failed to protect the lira.

The Turkish currency has been hitting record lows almost daily and has lost about 10 per cent since mid-December, when a corruption scandal roiling key Erdogan allies became public.

Risks remain

The central bank on Tuesday sharply raised its inflation forecast for 2014 to 6.6 per cent from 5.3 per cent.

The bank predicted that inflation would slow from the second half of 2014, but analysts said it was likely to remain high this year.

"Core inflation in Turkey is high and, with tax hikes and the weaker lira, inflation is likely to remain persistently high this year," economist William Jackson at the London-based Capital Economics told AFP.

Analysts said the risks remain for the Turkish economy.

"Turkey remains among the most fragile EMs (emerging markets)," commented Shearing.

"Unless the government follows the central bank's lead, by both tightening fiscal policy and toning down some of its more aggressive rhetoric, Turkey will remain vulnerable to further bouts of market turbulence".

The currencies of emerging economies have taken a beating recently, due in part to the US Federal Reserve's decision to reduce its stimulus measures, which curbs the attractivity of markets that had offered higher returns.

The Fed tapering "hits countries that tend to fund their deficits with short term money flows like Turkey," said Kathleen Brooks, research director at Forex.com.

Brooks listed Turkey among those countries with shaky economic fundamentals, particularly current account deficits, along with India, Indonesia, South Africa and Thailand.

But Erdogan played down tensions over the darkened economic outlook.

"The Turkish economy is quite robust and it is pressing ahead in a resilient way," he told parliament.

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