The remainder of the year in the Turkish economy: Interest rate cut expectations postponed due to war, inflation, and exchange rate pressure

As the Turkish economy enters the second half of the year, the main agenda has been the impact of war-related external shocks on inflation and exchange rates, and how much room the Central Bank can find on its interest rate path. While interest rate cuts were expected to begin gradually throughout 2026 at the start of the year, the rise in global uncertainties and the increase in energy prices have postponed these expectations.

The Central Bank of the Republic of Turkey (TCMB) kept the policy rate steady at 37 percent at its Monetary Policy Committee meeting on July 23.

The decision revealed that easing monetary policy before achieving a permanent decline in inflation is seen as a limited option. The reignition of the war indicates that pressure on exchange rates and pricing behavior continues.

Developments in the first half of the year showed that the weakening in global risk appetite could increase borrowing costs for economies sensitive to external financing, such as Turkey.

The process that began with the attacks by the US and Israel on Iran strengthened inflationary pressure through oil prices and supply chains. This picture made it difficult for the TCMB to make an earlier interest rate cut, despite complaints from the private sector regarding high interest rates.

The Central Bank's indication in its decision text of an expectation for a "temporary" increase in inflation in July is being evaluated as a sign that interest rate cuts could be discussed again in the autumn if war-related shocks weaken. However, this possibility depends on the course of oil prices, volatility in the exchange rate, and whether inflation expectations deteriorate.

GLOBAL SHOCKS CHANGED FORECASTS

In the main scenarios that stood out at the beginning of the year, it was expected that inflation would be around 23 percent by the end of 2026, the policy rate would fall to 28 percent, and growth would remain at the 4 percent level. In a more optimistic scenario, it was considered possible for inflation to drop to 18 percent, while in a pessimistic scenario, it was seen as approaching 29 percent.

However, after the first six months, the outlook shifted closer to the pessimistic scenario. The rise in energy prices and disruptions in supply chains lowered global growth forecasts while pushing global inflation expectations higher. The impact is more pronounced for Turkey; because dependence on energy imports and high production costs can cause external shocks to reflect more quickly on domestic prices.

For this reason, the probability of inflation hovering near the 29-30 percent band at the end of the year has strengthened. In such a picture, it can be expected that the TCMB will maintain its tendency to keep the real policy rate a few points above inflation. On the growth side, the expectations of nearly 4 percent at the beginning of the year are being replaced by a weaker outlook that has fallen to the 3 percent level.

Another important topic regarding external balances is the Euro/Dollar parity. At the beginning of the year, it was predicted that the parity could rise to the 1.25 level with the assumption of a more hawkish European Central Bank and a US Federal Reserve expected to cut interest rates. However, the dollar, strengthened by the war, brought a more likely picture of around 1.15 for the end of the year to the agenda. For Turkey, which makes a significant portion of its imports in dollars and a significant portion of its exports in euros, this change could have a negative impact on the current account balance.

SUSTAINABILITY TEST IN EXCHANGE RATE POLICY

The policy of real appreciation of the Turkish Lira is used as one of the important tools for the goal of reducing inflation. However, in economies where production is dependent on imported intermediate goods, a strong local currency can limit price increases on one hand, while increasing the current account deficit on the other. As the disinflation process drags on, this dilemma becomes more visible.

In the post-2001 period, the appreciation of the TL was largely supported by capital inflows. In recent years, the outlook on the exchange rate has been shaped more by controlled exchange rate policy and reserve management. This difference stands out as one of the fragile points of the current program. When the energy bill increased by the war and the impact of a strong TL on the foreign trade balance are combined, a faster easing of the real appreciation policy on the exchange rate may come to the agenda.

Indeed, it is observed that the monthly depreciation of the TL has recently risen to around the 1.8 percent level. This suggests that the delicate balance between financial stability and price stability is being recalibrated. Since a sudden correction in the exchange rate could disrupt the inflation outlook, the Central Bank is expected to take its steps in a controlled and gradual manner.

For the economy to settle on a healthier ground for the remainder of the year, relying solely on interest rate and exchange rate policy does not seem sufficient. Transitioning to a production model that reduces the chronic current account deficit could also lower the cost of the disinflation process. In this framework, more targeted incentives for exports, productivity, and investment are coming to the fore instead of broad-based support.

It is also critical for fiscal policy to shift towards areas that strengthen supply capacity rather than expenditures that increase demand. An early and rapid cut in interest rates or a sharp depreciation in the exchange rate before inflation permanently declines could create higher costs in terms of price stability and financial confidence in the medium term, even if it provides short-term relief.

News Source: 12punto