Turkey’s Economy Heads for Soft Landing After Dash to Hike Rates

(Bloomberg) -- Turkey’s economy probably cooled last quarter as the central bank moved to tighten monetary policy after May elections, a pivot that’s turning around sentiment among investors without crashing growth.

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The rapid-fire hikes in interest rates have put the brakes on lending and retail sales even as inflation continues to spiral higher. As a result, gross domestic product likely expanded just 1% from the second quarter in seasonally and working-day adjusted terms, down from 3.5% in the prior three months, according to the median forecast in a Bloomberg survey of analysts.

But some momentum likely carried over on an annual basis, with GDP growth reaching 5.3% in the third quarter from a year earlier, compared with 3.8% in the preceding period, a separate poll showed. The Turkish statistics agency will release the figures around 10 a.m. local time on Thursday.

The sharp turn away from accommodative policies had an immediate effect on the economy, said Selva Demiralp, a professor of economics at Istanbul’s Koc University. Another “important factor that suppressed the growth rate in third quarter is the low demand for Turkish exports due to the slowdown in Europe,” she said.

Turkey’s ability to eke out growth is important as it enters the final stretch before municipal ballots in March that could soften the resolve of policymakers while inflation accelerates past 60%. President Recep Tayyip Erdogan’s reelection in May set the stage for a shift in priorities with the appointment of a new team of technocrats anchored by Finance Minister Mehmet Simsek and central bank Governor Hafize Gaye Erkan.

What Bloomberg Economics Says..

“Leading indicators for the fourth quarter signal the central bank’s restrictive policies are beginning to impact activity. However, local elections in March 2024 may lead to further fiscal stimulus. Still, these figures are far lower than the above-5% average growth posted in the decade before the pandemic. Higher government spending would also be bad news for the central bank, as it would stoke inflationary pressures.”

— Selva Bahar Baziki, economist. Click here to read more.

The prospect of a soft landing for Turkey’s $1 trillion economy would be a vindication for Erkan, who’s argued that price stability is critical to sustainable growth. Prior to her appointment in June, Erdogan for years leaned on policies that pumped up the economy at the expense of inflation and the lira.

“In a situation when inflation and volatility are high, the disinflation process can be started with minimal compromise on growth until inflation falls back to certain levels,” Erkan said in a speech on Wednesday. “At this point the aim should be to maintain the disinflation process decisively.”

Monthly hikes since June have nearly quintupled the key rate to 40% in November, with a cumulative 15 percentage points of tightening delivered in the third quarter alone.

Still, a prolonged economic slump probably isn’t in the cards for Turkey, given the central bank initially took a gradual approach to tightening policy and with the country’s output gap remaining positive. A model developed by Demiralp together with fellow researchers at Koc University showed the probability of recession is at less than 20%.

Weakness in domestic demand is increasingly a drag on an economy where consumption made up nearly three-quarters of GDP over the past year. Growth in the average index of retail sales was near zero in July-September, after five straight quarters of gains of more than 5%, according to QNB Finansbank economists led by Erkin Isik.

“The ongoing monetary tightening and weak global demand may cause more deterioration,” they said in a report, adding that spending on earthquake relief efforts “may become a balancing factor.”

--With assistance from Joel Rinneby.

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