The Central Bank of Turkey unexpectedly cut interest rates by a large margin, exacerbating the pressure on the lira.

The Central Bank of Turkey significantly lowered interest rates on Thursday, sticking to a faster pace of rate cuts, disregarding Wall Street's expectations of a more pronounced slowdown. The Monetary Policy Committee reduced the one-week repo rate from 43% to 40.5%, a decrease of more than 200 basis points than investors had expected. The bank also reduced the overnight lending rate from 46% to 43.5%, and the overnight borrowing rate from 41.5% to 39%. Nick Riz, Head of Macro Research at London Monex Europe Ltd, stated after the decision was announced: "In our view, this seems like a fig leaf acknowledging market concerns while still indicating the central bank intends to loosen policy at a faster pace than many traders expected. We believe this situation will continue to pose resistance to the lira in the coming months." The lira's exchange rate remained relatively stable, at 41.295 lira to 1 US dollar. Prior to this unexpected rate cut, Central Bank Governor Naci Agbal had urged analysts to focus on core inflation data, stating that component data indicated demand-driven price pressures were still in line with deflationary trends. This suggested that the bank's rush to cut rate expectations earlier was a mistake. The Monetary Policy Committee echoed Agbal's comments in a statement accompanying the decision, saying: "The basic trend of inflation slowed in August. Although GDP growth in the second quarter exceeded expectations, domestic final demand remains weak." In August, the inflation rate rose to 33%, higher than economists' expectations; second-quarter economic growth (excluding the impact of the central bank's policy easing in July) remained strong. This led major banks such as JPMorgan Chase and Morgan Stanley to lower their forecasts for the magnitude of rate cuts. Turkish bank stocks gave back gains of up to 3.3% in early trading, narrowing to 0.3% gains currently. The yield on Turkish 10-year government bonds also narrowed gains, dropping 9 basis points to 32.77%. Lira actual appreciation policy adjustment The Central Bank also removed the phrase "pursuing the actual appreciation of the lira" from the decision explanation document. Maintaining lira actual appreciation (i.e. keeping the depreciation of the exchange rate lower than consumer inflation) has been a cornerstone of monetary policy makers' framework. This strategy has helped Turkey become one of the most profitable arbitrage trading targets globally in the past year - this investment strategy requires traders to borrow low-yield currencies to buy high-yield currencies. The Central Bank stated on Thursday that it will maintain a deflationary trend through "demand, exchange rate, and expectation channels." Deputy Governor Cetinkaya Akchaayi stated in August's quarterly inflation briefing that with inflation easing and its transmission effects on prices weakening, the intensity of lira actual appreciation might not be as strong as before. He added that in some cases, there may be a slight depreciation of the lira's actual exchange rate, as long as local assets remain attractive through tight policies. Riz pointed out: "It would be foolish to stick to a reference standard of lira appreciation while insisting on faster rate cuts than the market expects." Tufan Gjomert, an emerging markets strategist at BBVA, stated that the Central Bank still views the exchange rate as an important tool for deflation. He added: "This may mean subtle changes in the daily currency management approach, but we believe the current exchange rate system will not undergo major changes." Political unrest factors Turkish observers also face political uncertainty as the confrontation between the main opposition party and the judiciary has escalated, leading to bond and stock sell-offs. A case against the Republican People's Party (CHP) is scheduled to be heard on September 15, which could result in the dismissal of the party's national leadership and the appointment of a trustee by the court. Last week, a ruling declared the Istanbul meeting of the Republican People's Party invalid and suspended its municipal officials, increasing the likelihood of similar rulings against the party's central officials.