Inflation Slows in Turkey as Central Bank Cuts Rates Twice

Turkey’s Central Bank has begun reducing its key interest rate for the first time since February 2023, reflecting a decline in inflation that had been anticipated by analysts. However, inflation remains high at around 44.4% in December 2024, far from the government’s target of 21% by the end of 2025 and even further from the medium-term goal of 5%. Risks persist that could exacerbate Turkey's economic challenges.

Key Interest Rate Cuts

On December 2024, the Central Bank of Turkey reduced the key interest rate for the first time in nearly two years, cutting it from 50% to 47.5%. This marked a significant shift from its peak rate in over two decades. The Monetary Policy Committee (MPC) also revised the operational structure of financial policy, adjusting the overnight borrowing and lending rates to 150 basis points below and above the weekly repo rate, respectively.

On January 23, 2025, the Central Bank cut the rate further by 250 basis points to 45%, in line with analysts’ expectations. Experts noted that while core inflation remains relatively low, January could see a slight increase in inflation due to dynamic pricing in services and back-indexation mechanisms. The last quarter of 2024 showed that domestic demand remained disinflationary, but risks to economic stability persist.

Reasons Behind the Rate Cuts

Economists cited a combination of factors influencing the Central Bank's decisions:

- Slowing Inflation: Core inflation in goods remained subdued, while service sector inflation showed signs of improvement. Inflation in unprocessed food slowed in December following increases in the prior months.
- Declining Domestic Demand: Domestic consumption remained weak, contributing to reduced inflationary pressure.
- Economic Growth Concerns: The need to support economic growth while managing inflation expectations among businesses and households drove monetary easing.

President Recep Tayyip Erdoğan stated that interest rates would continue to fall in 2025, which he believes will help curb inflation. He emphasized that tools beyond monetary policy would also be utilized to combat inflation. Bloomberg noted that Erdoğan initially pursued ultra-loose monetary policies but shifted to orthodox policies in 2023 after appointing a new economic team post-election. The Central Bank subsequently raised rates from single digits to 50% in less than a year.

Challenges for the Central Bank

The Central Bank faces significant hurdles in managing excess liquidity, which reached a record 1 trillion liras ($28 billion) as policymakers accelerated dollar purchases. Economists at Goldman Sachs warned that the high cost of sterilizing this liquidity at current rates might push the Central Bank toward faster monetary easing. Recently, the Central Bank announced the discontinuation of lira deposits protected against exchange rate risks for terms of six months or one year.

Monetary Policy and Inflation Outlook

The Central Bank has committed to maintaining a tight monetary policy until price stability and a sustained decline in inflation are achieved. Officials also indicated that additional macroprudential measures could be introduced in response to unforeseen changes in credit and deposit markets.

Goldman Sachs and other analysts forecast a 250 basis point cut at every MPC meeting in 2025, though potential changes in U.S. Federal Reserve policies, global trade dynamics under President Donald Trump, and weaker-than-expected fiscal consolidation by Turkey’s Treasury and Finance Ministry could alter this trajectory.

Diverging Views on Policy Approach

Central Bank Governor Fatih Karahan appears inclined toward regular rate reductions without interruptions in the short term.
Deputy Governor Cevdet Akçay, however, advocates for a more cautious approach, suggesting that continuous easing could undermine the effort to combat inflation.

Economic and Inflation Projections

Annual inflation slowed to 44.4% in December 2024, with markets predicting it will decrease to 27% by the end of 2025. Karahan is set to present revised forecasts on February 7 during the Central Bank's quarterly review. Despite some improvements, inflation expectations remain well above the Central Bank’s year-end target of 21% and its medium-term goal of 5%.

Turkey’s Central Bank is navigating a complex economic landscape, balancing the need to support growth with the imperative to manage inflation. While recent rate cuts signal a shift toward easing, significant risks—both domestic and global—could influence the pace and effectiveness of this policy. Managing inflation expectations and excess liquidity will remain critical challenges in the months ahead.