Interest rates will not fall in the shadow of war and June 30

Things are getting harder in the economy every day. Even though Mehmet Şimşek has repeated hundreds of times that “the program is working,” the program is not working. Despite the great sacrifices made by large segments of society, the fight against inflation is not succeeding. Looking at domestic dynamics, we could see that the coming week would be a week of difficult decisions for the economy. With Israel striking Iran, it will now be a week of even more difficult decisions.

The question that has locked the economy and the markets is this: Will the Central Bank lower interest rates on June 19? If it does, by how much will it lower them?

Money market experts estimate that the Central Bank is not very eager to lower interest rates this month, and might perhaps pull the policy rate, which is 46 percent, down to 45 percent. But there is also a broad front expecting a strong interest rate cut with strong arguments against Mehmet Şimşek and the Central Bank. Let us also remind you that this broad front is not opposition, but rather business organizations that support the government, such as TOBB and MÜSİAD, as well as the pro-government media.

Leaving the Iran-Israel tension for the end of the article, let us first evaluate as if such a geopolitical crisis did not exist. Then, let us complete the article by adding the geopolitical risks that these conflicts have caused and will cause.

Let us look at the three main justifications of those who pressure the Central Bank to lower interest rates. First, I would like to remind you of this: Even if some of these justifications are valid, they do not reflect my thoughts. I am making observations. My economic thoughts are in the footnote of the article (1).

1- TUIK announced May inflation well below expectations, at around 1.5 percent. If interest rates are not lowered, it means that the Central Bank, like large segments of society, does not believe that TUIK measures inflation accurately. The Central Bank had announced the year-end inflation target as 29 percent as the upper limit. Providing a real interest rate of 17 points (13 percent in real terms) based on the 29 percent inflation it set itself for a 46 percent interest rate means Turkey is being robbed by hot money. The Central Bank skipping an interest rate cut, or cutting it at a level like 1 percent, will increase inflationary expectations in society.

2- Due to high interest rates, the business world has come to a halt. The decline in industry over the last month has reached a terrifying rate of 3.1 percent. Broad unemployment jumped from 28.8 percent to 32.2 percent in one month. 316 thousand people became unemployed in one month.

3- One of the most important foundations for those expecting an interest rate cut is the speech President Erdoğan made on May 30 at the 2nd Istanbul World Islamic Economics Summit:

“I am a brother of yours who has resolutely fought against an interest-based economic system. I will continue to voice my longing for an interest-free economy with a loud voice from now on.”

A CRUCIAL QUESTION… SINCE INFLATION WILL FALL…

Meanwhile, the issue is not limited to the Central Bank's interest rate cut or inflation expectations. A crucial question came from economist İris Cibre. The question on İris Cibre's X account on June 10 is as follows:

“A total of 13 Treasury bond auctions were held between April and today, 9 of which were for maturities longer than 2 years. Why is the Treasury borrowing heavily long-term at high interest rates? Especially when there is a period ahead where interest rates will start to fall, and when it could have borrowed short-term?”

The question is good and pertinent. Our colleague Alaattin Aktaş from Ekonomim Newspaper also took the question as a perfect pass and wrote a very pertinent article on June 12. The summary is this:

“If it is known today, for example, that the 40 percent interest rate will fall to 20 percent a year later; would you borrow for two, three, or five years at 40 percent interest today? If you do, you will go bankrupt! But if you think that interest rates, and in a sense inflation, will not decline, you do not see any harm in borrowing at high interest rates… In other words, the Treasury is saying this: ‘The Central Bank projects inflation at 12 percent in 2026, 8 percent in 2027, and 5 percent thereafter, but I will pay 38-39 percent interest throughout all these years and even in 2029.’ I wonder… Is the borrowing strategy wrong, or is it not believed that inflation and interest rates will fall?”

I THINK THERE IS ANOTHER SCENARIO

What I can add to these two pertinent questions and comments cannot go beyond speculation. Either, now that there is an opportunity, there is an intention to transfer resources to a certain group, like the Treasury-guaranteed bridges and highways…

Or… I repeat, this is not a rumor, it is a guess… Or if it were me, what would I do? Mehmet Şimşek and the Central Bank might have taken their precautions against the pressures for interest rate cuts and asked the President the following:

“We were already going to lower the policy rate from 42.5 percent to 40 percent in April. However, we had to increase interest rates due to the March 19 effect (the İmamoğlu operation). So far, we have only recovered 25 percent of the foreign exchange reserves we burned. Hot foreign currency has started to come in again via Carry Trade. Yes, inflation is falling, but if a new development similar to March 19 occurs, let alone cutting interest rates, we might have to increase them even further…”

Those who construct monetary policy in a country governed like Turkey will certainly discuss this scenario. When they do not receive a satisfactory answer, they will move away from an interest rate cut, and perhaps they will even see this current interest rate as advantageous for the future.

In my opinion, the decision regarding the CHP congress on June 30 does not only worry the CHP management. I estimate that Mehmet Şimşek and the Central Bank feel the same concern.

Furthermore, no one is sure that the operations carried out against the Istanbul Metropolitan Municipality on June 30 and thereafter will not spread to other metropolitan municipalities.

Because of these internal dynamics, I expected the Central Bank to keep the policy rate at 46 percent, and perhaps lower it to 45 percent in the face of pressure. However, with Israel's attack on Iran and Iran's retaliation, expectations have also changed.

INTEREST RATES DO NOT FALL IN A WAR ENVIRONMENT

Immediately after the Israeli attack, oil prices increased by around 7 percent. Judging by the statements made by the US, Israel, and Iran, the tension is expected to last a long time. Iran closing the Strait of Hormuz will affect the shipment of oil and liquefied natural gas from Saudi Arabia and Gulf countries, which could cause oil prices to rise even further. As a first effect, there have already been consecutive price hikes for gasoline and diesel. These hikes will exert inflationary pressure in every field, from agriculture to industry, the distribution chain, and the retail sector.

Instability in the region has increased Turkey's risk premium (CDS). Turkey's borrowing costs will increase. Along with geopolitical risks, it is also possible that tourism will be affected, the incoming hot money will exit, and the demand for foreign currency by foreigners and locals will increase…

If we add the inflationary effect of geopolitical risks and the possible jump in foreign currency demand to the internal June 30 CHP Congress case and the possibility of operations against other metropolitan municipalities, in my opinion, the Central Bank's interest rate cut has been left for another spring. But may he rest in peace, let us complete the article with a quote from our late elder, the valuable academic, economist, and journalist Güngör Uras.

“This is Turkey, my brother. Anything can happen at any moment.”

(1) My political-economy construct is one that prioritizes a planned, public-oriented, social state, development, fair distribution, a balanced budget-fair tax system, and envisions structural changes in many areas, especially in law. I wrote about this Political-Economy construct in my book, Turkey's Factory Settings for the Twenty-First Century / Counter-Revolution in the Economy. It can be obtained online from the amazon.com.tr website.