Turkish lira soars after unexpected decision of the Central Bank of Turkey

The key rate hike caused the Turkish lira to increase by 6%.

The Turkish Central Bank shocked the markets with an unexpected increase of 750 basis points in the rate all at once.

On Thursday, the dollar exchange rate against the Turkish lira dropped to 25.3 liras, which is the lowest it has been since the end of June. The rate began the day at 27.2 liras.

The Bank of Turkey surprised many by raising the key rate from 17.5% to 25%, a jump of 750 basis points, causing the Turkish currency to appreciate significantly. This was much higher than the 250 basis point increase to 20% that most analysts surveyed by Bloomberg had predicted.

RBC writes that the regulator's decision was motivated by his wish to quickly initiate deflation, stabilize inflation expectations, and prevent the decline in price movements.

In June, after the selection of Hafize Gaye Erkan, who had experience in Goldman Sachs and First Republic of the United States, as the leader of the regulator, Turkey's central bank started to implement a tighter monetary policy.

In June, the Central Bank raised the rate from 8.5% to 15%, almost doubling it. This was followed by an even higher rate of 17.5% in July, marking the first time the regulator had increased the rate in over two years.

After President Erdogan won the elections in May, he promised to implement a more orthodox economic policy. Despite the fact that inflation had risen to 85% last year, the key rate in Turkey had been kept at a low level for a prolonged period of time.

In Touch Capital Markets notes that the rate hike sends a powerful message that the Central Bank is intent on controlling inflation, and the initial market response has been very favorable.

Erkan's decision could have a major impact, potentially allowing the central bank to increase rates to a much higher level in order to tackle Turkey's macroeconomic issues. Capital Economics has raised the question of whether President Erdogan approved of this decision, as it could lead to Erkan's dismissal.