By Nevzat Devranoglu and Daren Butler
ISTANBUL (Reuters) -Turkey's central bank hiked its key interest rate by 350 basis points to 46% on Thursday, in a surprise move that reversed an easing cycle and boosted Turkish assets following market turmoil triggered by the arrest of Istanbul's mayor last month.
The policy pivot - just four months after rate cuts had begun - aimed to ease weeks of pressure on the lira that forced the central bank to tap its foreign currency reserves, and to push back on rising inflation expectations, analysts said.
Last month, the lira briefly hit a record low of 42 to the U.S. dollar and stocks and bonds plunged after the detention of Istanbul Mayor Ekrem Imamoglu, pushing the central bank to take several steps to ease the market fallout.
The bank said "recent developments in financial markets" are expected to slightly lift monthly core goods inflation in April, adding domestic demand is above projections, "suggesting a lower disinflationary impact".
"Inflation expectations and pricing behaviour continue to pose risks to the disinflation process," the central bank's policy committee said as it announced its decision.
Further tightening would be needed "in case a significant and persistent deterioration in inflation is foreseen", it added.
The central bank started easing in December, when the rate was 50%, marked the apparent end of an aggressive tightening effort since mid-2023 to bring down years of soaring prices and a series of currency crashes.
In a Reuters poll, only three of 13 respondents forecast a hike of up to 350 basis points in the one-week repo rate, while the others predicted a pause.
Most also expected the overnight lending rate would be held at 46% after the bank had already lifted it last month after the mayor's arrest. But it was also raised to 49% on Thursday, while the overnight borrowing rate was set at 44.5% from 41% earlier.
POLITICAL CONCERNS
The lira strengthened slightly after the decision and traded at 38.07 to the dollar, while the benchmark stock index BIST 100 and banking index pared back some of their gains during the day.
The rate decision came amid global market turmoil caused by what has become an all-out trade war between the United States and China, with both sides ratcheting up their import tariffs.
Economists expect the recent roughly 3% weakening of the lira - due chiefly to Imamoglu's arrest on March 19 - to lift April and May inflation readings.
Annual inflation had slowed to 38.1% in March, and the central bank expects it to hit 24% by year end.
Imamoglu - President Tayyip Erdogan's chief rival - is now jailed pending trial in legal moves that sparked the biggest protests in more than a decade and broad criticism of a politicised judiciary and erosion of the rule of law, criticism rejected by the government.
"Markets will stay sceptical amid the ongoing crackdown on Turkey's political opposition," said Erik Meyersson, chief emerging market strategist at SEB, adding he expects cuts to resume in June, bringing the rate to 32% by year end.
Since Imamoglu's arrest, the central bank has sold some $50 billion in reserves and bought about 120 billion lira ($3.15 billion) worth of bonds. In response, the lira has steadied near 38 to the dollar and Turkish assets have recovered somewhat.
Before the latest tightening, the bank had also paused funding through one-week repo auctions, already effectively tightening funding conditions by 400 basis points.
The bank, which said on Thursday it would resume the one-week repo auctions, also vowed to closely monitor liquidity conditions.
($1 = 38.1429 liras)
