The Central Bank of Turkey just announced massive rate hikes.

It raised the overnight lending rate to 12%, from 7.75%. Economists polled by Bloomberg were looking for a hike to 10%.

It raised the benchmark repurchase rate to 10%, from 4.5%. Economists were looking for this to be left unchanged.

The overnight borrowing rate was brought up to 8% from 3.5%. The overnight borrowing rate was also expected to be left unchanged.

Today’s emergency bank meeting came as the central bank attempted to stem the decline of the Turkish lira.

The lira firmed to 2.1925 to a dollar after the announcement, from 2.2591 ahead of the meeting. The currency touched a record low of 2.390 lira to a dollar on Monday.

The lira has recently taken a beating on the back of a corruption probe threatening prime minister Tayyip Erdogan and the ruling AKP party. And anti-government sentiment has picked up since the Gezi Park protests in Istanbul last summer which have raised investor concerns.

Of course Turkey’s problems go beyond political uncertainty. Like the other ‘Fragile Five’ nations, Turkey has a current account deficit problem. And there is the fact that its economic growth has largely been driven by construction which is bound to get more expensive as interest rates are rising. From the press release:

“Recent domestic and external developments are having an adverse impact on risk perceptions, leading to a significant depreciation in the Turkish lira and a pronounced increase in the risk premium. The Central Bank will implement necessary measures at its disposal to contain the negative impact of these developments on inflation and macroeconomic stability. In this respect, the Committee decided to implement a strong monetary tightening and to simplify the operational framework.

“Tight monetary policy stance will be sustained until there is a significant improvement in the inflation outlook. Under this policy stance, inflation is expected to reach the 5 per cent target by mid-2015. ”

Ahead of the announcement, Erdogan reiterated that he was not in favour of rate hikes but maintained that the central bank is an independent entity.

Erdogan continues to be focused on growth in a year when Turkey sees municipal elections (in March) and a presidential election (in August).

“I think the central bank is desperate to stop the move lower, and realises the inadequacy of its current interventions,” Enis Taner macro editor at Risk Reversal and former trader at Goldman Sachs, told Business Insider on Monday. “If they do hike rates a couple per cent on the upper band, then I think it will calm the currency in the near-term.”

“No one should be in doubt that the central bank will use all its policy tools to converge inflation to the 5% target,” central bank governor Erdem Basci is quoted saying in the Wall Street Journal. “Our aim at tonight’s meeting is to avoid a deterioration of pricing behaviour and to take steps to ensure price stability. …We won’t refrain from implementing permanent policy tightening if needed.”

Markets will be watching to see if other emerging market central banks make similar moves.

Click here for the full press release »

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