Turkey’s Central Bank Delivers Cautious 100 Basis Point Rate Cut to 37% as Inflation Risks Persist

Turkey’s Central Bank of the Republic of Türkiye delivered a more cautious than expected 100 basis point reduction in its benchmark interest rate on Thursday, lowering the one-week repo rate to 37% in its first policy meeting of 2026 and marking the fifth consecutive easing move since the bank resumed its rate-cutting cycle last summer. The decision, which fell short of the median market forecast of 150 basis points, reflects growing caution among policymakers as they navigate the delicate balance between supporting economic growth and maintaining control over inflation that remains stubbornly elevated at more than six times the central bank’s medium-term target.

The monetary policy committee’s decision underscores the complex challenges facing Turkish policymakers as they attempt to engineer a soft landing for an economy that has experienced years of volatility, unconventional monetary policy experiments, and persistent inflation pressures that have eroded purchasing power for millions of Turkish households. While recent months have seen encouraging signs of disinflation, with annual inflation slowing to 30.9% in December 2025 from over 44% a year earlier, central bank officials remain wary of declaring premature victory in the battle against rising prices.

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Market Expectations and Policy Signaling

Financial markets had widely anticipated a larger rate reduction, with the Reuters Poll showing a median estimate of 150 basis points—the same magnitude as December’s cut—though several economists had predicted the smaller decrease given expectations that the pace of disinflation would moderate in coming months. The central bank’s decision to proceed with a more modest cut sends a clear signal about its commitment to maintaining a restrictive monetary policy stance despite political and economic pressures to accelerate the easing cycle.

In its post-meeting statement, the Monetary Policy Committee acknowledged that “while showing signs of improvement, inflation expectations and pricing behavior continue to pose risks to the disinflation process.” This careful language reflects the central bank’s recognition that achieving sustainable price stability requires more than just favorable headline inflation numbers—it demands fundamental changes in how businesses set prices and how consumers and investors form expectations about future inflation.

The committee noted that while leading indicators suggest monthly consumer inflation has firmed in January, led by food prices, “the rise in the underlying trend of inflation is limited.” This distinction between headline inflation, which can be volatile due to temporary factors, and underlying inflation trends represents a sophisticated approach to monetary policy that considers the persistent drivers of price pressures rather than reacting to short-term fluctuations.

Inflation Dynamics and Recent Trends

Turkey’s inflation trajectory has shown remarkable improvement from the crisis levels seen in recent years, though the current 30.9% annual rate remains far above the levels considered compatible with economic stability and sustainable growth. The December reading marked the fourth consecutive monthly decline and represented the lowest level since November 2021, providing some vindication for the central bank’s tight monetary policy stance maintained throughout much of 2024.

The monthly increase of 0.89% in December came in below market expectations of 0.98%, with the favorable surprise largely attributable to easing food prices that had been a major driver of inflation pressures in earlier months. Food and non-alcoholic beverage prices, which carry significant weight in Turkish household budgets and therefore in the consumer price index, rose 28.31% annually in December, moderating from 27.44% in November but still representing a substantial burden on household purchasing power.

However, central bank officials and market analysts recognize that the inflation outlook for early 2026 is clouded by several factors that could cause temporary spikes in price readings. The 27% increase in the minimum wage that took effect in January 2026, while below the annual inflation rate and therefore representing a real-terms pay cut for minimum wage earners, nonetheless feeds through to production costs and consumer demand in ways that can temporarily boost inflation.

Additionally, the traditional new-year period in Turkey sees numerous businesses implementing annual price adjustments for goods and services, creating what Central Bank Governor Fatih Karahan has characterized as “noisy” readings in January and February that may not reflect underlying inflation trends. In a recent presentation to investors, Karahan suggested that lower inertia in services inflation would support continued disinflation despite these temporary factors.

The Long Road from Peak Rates

The current 37% policy rate represents a dramatic decline from the 50% peak reached in March 2024, when the central bank completed an aggressive tightening cycle that began in mid-2023 under new leadership committed to more orthodox monetary policy approaches. That tightening campaign, which saw rates rise from just 8.5% to 50%, represented a sharp reversal from the unconventional low-rate policies that had characterized Turkish monetary policy under President Recep Tayyip Erdoğan’s long-standing belief that high interest rates cause inflation—a theory at odds with mainstream economic thinking.

The central bank maintained the 50% rate for most of 2024, using that extended period of tight money to wrestle down inflation expectations that had become deeply entrenched after years of double-digit price increases. This patient approach, while painful for borrowers and potentially constraining for economic growth, helped establish the central bank’s credibility and demonstrated its commitment to breaking the back of inflation rather than prematurely declaring victory.

The easing cycle that eventually commenced faced an unusual interruption early in 2025 due to political turmoil surrounding the detention and arrest of Istanbul’s mayor, which triggered market volatility and lira weakness that temporarily forced the central bank to reverse course. In April 2025, the bank delivered a surprise 350 basis point rate hike to 46%, using the shock move to stabilize markets and demonstrate that it would not hesitate to tighten policy if financial stability came under threat.

Once that political storm passed and market conditions stabilized, the central bank resumed cutting rates in July 2025 with an aggressive 300 basis point reduction, followed by a 250 point cut in August, a more measured 100 point reduction in October as food price pressures emerged, and then 150 points in December before this week’s 100 point move. In total, the central bank has eased by 900 basis points since last summer and by 1,300 points from the 50% peak, representing a dramatic shift in monetary conditions though rates remain highly restrictive in both nominal and real terms.

Forward Guidance and Policy Trajectory

Market expectations for further easing remain robust, with the Reuters poll conducted last week suggesting the central bank will continue reducing rates toward 28% by the end of 2026. This projection implies roughly 900 additional basis points of cuts over the year, though the path toward that endpoint is likely to be uneven and dependent on incoming inflation data, global financial conditions, and domestic political developments.

The central bank has publicly committed to reaching its 16% interim inflation target by end-2026, with projections spanning a range between 13% and 19%. These forecasts reflect both the central bank’s base case scenario and the recognition that significant uncertainty surrounds the inflation outlook, with risks posed by potential external shocks, domestic policy changes, or unexpected shifts in key price components like food and energy.

Market participants remain more skeptical about the inflation outlook than the central bank’s official projections suggest, with many analysts predicting year-end 2026 inflation will come in above the upper bound of the central bank’s forecast range. Wall Street consensus estimates see Turkish inflation easing to approximately 25% by end-2026, still well above the central bank’s 16% target but representing substantial improvement from current levels.

This divergence between official forecasts and market expectations creates a challenging environment for monetary policy communication. If the central bank cuts rates as aggressively as markets currently expect but inflation proves stickier than official projections, the resulting policy credibility damage could undermine the hard-won gains in anchoring inflation expectations. Conversely, if the bank moves too cautiously and inflation declines faster than anticipated, it risks unnecessarily constraining economic growth and employment.

In its Thursday statement, the central bank reiterated that its monetary policy stance “will be maintained until price stability is achieved” and will work “through demand, exchange rate, and expectation channels” to strengthen the disinflation process. Critically, the committee emphasized that “the step size is reviewed prudently on a meeting-by-meeting basis with a focus on the inflation outlook,” preserving flexibility to adjust the pace of easing based on evolving conditions.

The statement also included important qualifications about the bank’s willingness to reverse course if needed: “Monetary policy stance will be tightened in case of a significant deviation in inflation outlook from the interim targets.” This conditionality provides insurance against market complacency and signals that the easing cycle is not on autopilot but rather conditional on continued progress toward price stability.

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Macroeconomic Context and Growth Dynamics

Turkey’s economic performance in 2025 demonstrated resilience in the face of tight monetary conditions, with GDP growth moderating to sustainable levels while avoiding the sharp contraction that some observers had feared. Third-quarter GDP growth of 3.7% year-over-year came in below expectations but at a 1.1% seasonally adjusted quarterly rate, defying predictions of a sharp slowdown and suggesting that domestic demand remained reasonably robust despite restrictive monetary conditions.

This growth performance, while slower than the boom years that characterized earlier periods of Turkish economic development, represents a more sustainable trajectory that reduces the risk of overheating and inflationary pressures building up through excess demand. The central bank’s approach appears designed to maintain this balance—keeping growth positive but at moderate levels that don’t reignite inflation while the disinflation process continues.

Looking ahead to 2026, economic forecasts suggest continued moderate growth in the 3-4% range, supported by recovering tourism revenues, gradual improvement in external demand from Turkey’s European trading partners, and the stimulative effects of monetary easing as rate cuts work their way through the economy with typical lags. However, significant headwinds remain, including the continued erosion of household purchasing power, uncertainty about global economic conditions, and potential volatility in capital flows depending on international investor sentiment toward emerging markets.

The Turkish lira’s performance will play a crucial role in the inflation and growth outlook. The currency has depreciated substantially over recent years, losing approximately 20% against the dollar in 2024 alone, contributing to inflation through higher import costs while providing some competitive advantage for Turkish exporters. The central bank’s commitment to maintaining positive real interest rates—where policy rates exceed inflation—aims to support the lira by making Turkish-denominated assets more attractive to both domestic and international investors.

Fiscal Policy Coordination and Structural Challenges

The effectiveness of monetary policy in controlling inflation depends significantly on complementary fiscal policy measures that avoid adding to demand pressures or undermining central bank credibility. Treasury and Finance Minister Mehmet Şimşek has implemented a reform program aimed at improving fiscal discipline, reducing subsidies, and creating fiscal space for targeted social programs that can ease the burden of disinflation on vulnerable populations.

The government’s medium-term program estimates the budget deficit will end 2025 at approximately 1.4% of GDP before gradually narrowing to 1% through 2028, representing a significant improvement in fiscal sustainability compared to earlier periods of looser fiscal policy. However, achieving these targets requires difficult political choices about spending priorities, particularly given pressures to increase support for households struggling with high inflation and weak real wage growth.

The minimum wage increase to 28,075 lira ($655) monthly represents a political compromise between competing pressures—large enough to provide some nominal income growth for the roughly one-third of Turkish workers earning minimum wage, but below the inflation rate and therefore representing a real-terms income decline. Labor unions, particularly the Türk-İş confederation, have sharply criticized the increase as insufficient and below the calculated “hunger threshold” for a family of four, highlighting the social tensions created by the disinflation process.

Structural economic reforms beyond monetary and fiscal policy will be critical for Turkey to achieve sustained low inflation and strong growth over the medium term. These include measures to increase labor force participation, particularly among women; improvements in education and skills training; regulatory reforms to enhance competition and reduce monopolistic pricing; and governance improvements to strengthen institutions and the rule of law. While these reforms typically show results only over longer time horizons, they represent essential foundations for economic convergence with more developed economies.

Currency Markets and External Balance

The Turkish lira’s trajectory reflects both the legacy of past economic mismanagement and gradual improvement in fundamentals as orthodox policies take hold. While the currency continues to face depreciation pressures, the pace of decline has moderated compared to earlier crisis periods, and the central bank has built up foreign exchange reserves that provide a buffer against potential volatility.

Turkey’s current account balance has shown significant improvement, with the deficit narrowing substantially from peak levels as import demand moderated in response to tighter monetary conditions and slower domestic growth. Robust export performance, particularly in manufacturing and tourism sectors, has helped offset energy import costs that remain substantial given Turkey’s limited domestic energy resources.

Foreign investor sentiment toward Turkey has improved gradually, with portfolio inflows resuming in late 2024 and continuing into 2025 as investors gain confidence in the sustainability of orthodox economic policies. However, this confidence remains fragile and could quickly reverse if political interference in monetary policy resurfaces or if inflation proves more stubborn than anticipated.

The central bank’s commitment to allowing gradual real appreciation of the lira—through keeping nominal depreciation below the inflation rate—aims to support disinflation by reducing pass-through from import prices while avoiding the sharp appreciation that could undermine export competitiveness. This delicate balancing act requires careful management of interest rate policy, foreign exchange interventions, and communication to shape market expectations.

Political Economy and Institutional Challenges

Turkey’s monetary policy operates within a complex political economy where the central bank’s formal independence has at times been undermined by political pressures and interventions. President Erdoğan’s well-documented skepticism of high interest rates and his past dismissals of central bank governors who resisted pressure to cut rates have created credibility challenges that the current leadership continues working to overcome.

The appointment of Fatih Karahan as governor has brought technical expertise and a commitment to data-driven policy, but the ultimate test of central bank independence will come if political pressures for faster rate cuts intensify while inflation remains elevated. The central bank’s cautious approach to this week’s rate decision may reflect not only economic considerations but also an effort to demonstrate that policy decisions are driven by inflation dynamics rather than political expediency.

Public discourse around monetary policy in Turkey often reflects the tensions between short-term political considerations and longer-term economic sustainability. While tight money creates tangible pain for borrowers and may constrain growth, the alternative of premature easing risks reigniting inflation and ultimately causing even greater economic damage. Building public understanding of these tradeoffs remains an ongoing challenge.

Regional Economic Context and Comparisons

Turkey’s inflation challenges, while severe by developed economy standards, must be understood within the broader context of emerging market economies that have grappled with similar pressures in recent years. Global commodity price shocks, particularly for food and energy, have tested monetary policy frameworks worldwide, and Turkey’s experience offers lessons about both the costs of heterodox policies and the potential for recovery under more conventional approaches.

Comparisons with other emerging markets show that Turkey’s inflation rate, while declining, remains elevated relative to regional peers. This reflects both the depth of Turkey’s previous inflation problem and the time required to fully restore price stability once inflation expectations have become unanchored. However, the direction of change—with inflation declining and real interest rates positive—represents encouraging progress that, if sustained, could eventually restore Turkey’s competitiveness as an investment destination.

The broader geopolitical context also shapes Turkey’s economic outlook, with the country’s strategic position between Europe and the Middle East creating both opportunities and vulnerabilities. Regional conflicts, energy market dynamics, and shifts in global trade patterns all influence Turkey’s external balances and create additional sources of uncertainty for monetary policy planning.

Looking Ahead: Challenges and Opportunities

The path forward for Turkish monetary policy involves navigating multiple challenges while capitalizing on emerging opportunities. On the challenge side, the central bank must continue reducing inflation toward its 5% medium-term target while managing the political and social costs of the tight money required to achieve that goal. Wage pressures, food price volatility, potential energy shocks, and currency depreciation all threaten to slow or reverse disinflation progress.

Market credibility remains fragile and could be damaged by policy mistakes in either direction—cutting too fast and allowing inflation to reaccelerate, or maintaining overly tight policy that unnecessarily constrains growth. The central bank’s communication strategy must therefore carefully balance confidence in the disinflation process with appropriate humility about the uncertainties and risks that remain.

On the opportunity side, Turkey’s young population, strategic location, manufacturing capabilities, and large domestic market provide foundations for strong economic performance if macroeconomic stability can be sustained. Structural reforms that improve business environment, enhance education outcomes, and increase labor force participation could unleash productivity gains that support higher living standards while keeping inflation under control.

The recent experience has demonstrated that orthodox monetary policy can work in Turkey when given sufficient time and political support. Annual inflation has declined by more than 13 percentage points over the past year, real interest rates have turned positive, and economic growth has moderated to sustainable levels without collapsing. While significant work remains, these achievements provide reason for cautious optimism about the inflation outlook.

Conclusion

Turkey’s central bank decision to cut interest rates by 100 basis points to 37%, while below market expectations, reflects a pragmatic approach to monetary policy that balances the desire to support economic growth with the imperative of consolidating gains against inflation. The cautious stance acknowledges that inflation risks persist despite encouraging recent trends, and that maintaining credibility requires demonstrating commitment to the inflation target even when political and economic pressures push toward faster easing.

The road ahead remains challenging, with the central bank projecting continued rate cuts toward 28% by year-end while targeting 16% inflation. Success will require not only skillful monetary policy execution but also supportive fiscal policy, structural reforms to enhance productivity and competition, and perhaps most critically, sustained political commitment to orthodox economic management even when the short-term costs are politically uncomfortable.

For Turkish households and businesses, the stakes could not be higher. Success in achieving sustainable low inflation would restore purchasing power, reduce uncertainty, and create conditions for investment and employment growth. Failure would risk a return to the inflation-driven economic volatility that has characterized too much of Turkey’s recent history. This week’s rate decision suggests policymakers understand both the progress achieved and the work that remains.

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By: Montel Kamau

Serrari Financial Analyst

23rd January, 2026