The Turkish central bank will keep its monetary policy tight until there is a clear improvement in the inflation outlook, Governor Erdem Basci told a parliamentary commission in a presentation published on Wednesday.
"The positive impact of macroeconomic measures adopted early this year and the tight stance in monetary policy is observed on core inflation trends," Basci told the parliament's planning and budget commission, according to the presentation.
A slump in the Turkish lira driven by a sell-off on emerging markets plus investors' nerves about domestic politics have diminished expectations of interest rate cuts, putting pressure back on the central bank before elections next June.
Just last week Basci said falling oil prices, now at a 5-1/2-year low, could help Turkish inflation to drop near to 5 percent next year, suggesting the bank would have more room to deliver the interest rate cuts President Tayyip Erdogan has long called for.
But the lira's fall to a series of record lows in recent days, dipping to beyond 2.41 against the dollar on Tuesday, risks increasing Turkey's import bill and reducing the bank's room for maneuver.
"The door for the central bank's rate cut is now shut. I believe the pressure on the lira will remain and may even accelerate," Ugur Gurses, a columnist and a former central banker, told Reuters.
Expectations of higher U.S. interest rates are sucking money out of emerging markets across the globe but investors are also worried about the direction of Turkish politics. Erdogan has vowed to hunt down the "traitors" behind popular anti-government protests last year and a corruption scandal which emerged just over six months later.
Far from cutting rates, the central bank could even be forced to raise them, some economists said. That would be deeply unpopular with a government bent on going into the parliamentary elections with strong economic growth and low inflation.
The ruling AK Party has built much of its reputation on strong economic management over the past decade. Erdogan, who takes the view that high interest rates cause inflation, has repeatedly called for rate cuts to support growth.
The bank tightened lira liquidity in the interbank market on Tuesday to try to support the lira, with its average funding rate rising to 8.85 percent from 8.79 on Monday.
It also said it would cover part of the foreign exchange needs of state energy importers, which buy gas in dollars under long-term supply deals, in an attempt to stem dollar demand.
The lira's rapid fall has drawn comparisons with late January. A slump then caused by political tensions and another emerging market sell-off forced the central bank into more than doubling its main one-week repo rate after a series of failed currency market interventions.
This time, it would be more likely to raise its overnight lending rate - the upper end of the interest rate corridor it uses to manage liquidity conditions - than eat into foreign exchange reserves with direct interventions, Gurses said.
"The central bank seems to have learnt its lesson. It will first reduce the lira liquidity and then may raise the upper band to fight the lira's slide," he said.
Eyes on the fed
Statistical effects and the decline in the oil price are still expected to lead to an easing of headline inflation early next year, analysts said, but not by enough to allow a rate cut.
That means the central bank may struggle to support growth as the economy slows, a headache for Erdogan who called as recently as last week for lower interest rates.
Political pressure on the central bank has eased since Erdogan won a presidential election in August and Ahmet Davutoglu, a trained economist, succeeded him as prime minister and AK leader.
But Erdogan wants the AK party to win at least two thirds of the vote in June - which would enable him to change the constitution more easily and create the presidential system he has long wanted - and knows the economy will be crucial.
"The administration ... seems to be quite nervous about winning the elections with a very strong mandate to reform the constitution," said UBS strategist Manik Narain.
Economic growth slowed more sharply than expected in the third quarter to 1.7 percent year-on-year.
Basci said the growth had come solely from exports and that the fourth quarter may be slightly stronger, but noted weak European demand and political tensions in Middle Eastern and Russian export markets were challenges.
Turkey's economic fate in the weeks ahead also hinges on U.S. monetary policy, particularly if Federal Reserve chief Janet Yellen were to indicate at a meeting on Wednesday that benchmark rates might rise earlier than expected.
This could lead to a further outflow from emerging markets into U.S. assets in pursuit of better returns.
Atilla Yesilada from Istanbul Analytics said the roadmap for Turkey's central bank would be drawn after the Fed statement.
"The fate of emerging market currencies rests with Yellen."