Turkey raises overnight rate to support economy

The Turkish central bank raised its overnight rate by 0.75 percentage points to 7.25 percent on Tuesday, as it fights to support its currency from a flight of foreign capital. But the bank held its key rate at 4.5 percent, the level to which it was reduced in May. But a week ago, the bank hinted that it might now have to tighten monetary policy to shore up the lira. "If necessary, more measures will be taken," the bank said. Turkey has achieved strong economic growth in the last decade after severe financial crisis and IMF rescues, and is now an economic powerhouse in its region. The economy is estimated to be about the 17th-biggest in the world. But it is also extremely vulnerable to rapid flows of foreign capital and has been hit hard by talk of central banks in the US and elsewhere winding up stimulus policies that have encouraged investors to Turkey's door. With the economy now sputtering, and after a wave of demonstrations sparked at least in part by a frustrated middle class, the central bank has been under strong pressure from the government to hold rates down."By tightening policy, the central bank is simply bowing to the inevitable - in times of market turbulence countries with large current account deficits, such as Turkey, need high interest rates," said Neil Shearing, Chief Emerging Markets Economist. And following the decision, the lira strengthened, "but nonetheless, Turkey's current account deficit leaves it vulnerable to a fresh deterioration in investor sentiment," Shearing said. The Turkish Lira has been under the gun ever since the US Federal Reserve alarmed the world with talk that it would scale back easy money monetary stimulus. In its rapid effort to support the lira, the central bank sold nearly $6 billion in operations economists say Turkey can only sustain for a limited time. "Movements in the lira will be critical to determining what happens next," Shearing said. The currency crash last month coincided with unprecedented street protests against the Islamist-rooted government of Recep Tayyip Erdogan that sent the stock market in Istanbul plummeting. At that time Erdogan attacked those whom he termed speculators, and the interest rate lobby, meaning people who argued that an increase in rates was needed to shore up the lira and encourage capital to stay. Erdogan's Justice and Development Party (AKP) gained power in 2002. Since then, the economy has recovered with strong growth exceeding 8.0 percent in 2010 and 2011. The government was counting on far slower growth of 4.0 percent this year. Turkey does about half of its external trade with the eurozone and has suffered from weak growth and domestic demand in Europe. The country is running a structural trade deficit estimated at 6.3 percent of gross domestic product this year.