Turkey's central bank promises action after inflation surges to 18 percent

By Ali Kucukgocmen and David Dolan

ISTANBUL (Reuters) - Turkey's central bank signalled on Monday it would take action against "significant risks" to price stability, a rare move to calm financial markets after inflation surged to its highest in nearly a decade and a half.

The comments, seen as presaging an interest rate increase at the bank's next meeting on Sept. 13, underscore the volatile outlook for prices amid a currency crisis. The lira has lost 40 percent of its value against the dollar this year, driving up the cost of goods from potatoes to petrol and sparking alarm about the impact on the wider economy.

Inflation jumped 17.9 percent year-on-year in August, official data showed, outstripping market expectations and marking its highest level since late 2003.

"Recent developments regarding the inflation outlook indicate significant risks to price stability. The central bank will take the necessary actions to support price stability," the bank said shortly after the release of the inflation data.

"(The) monetary stance will be adjusted at the September monetary policy committee meeting in view of the latest developments."

For investors, the main question has been whether the central bank will be able to sufficiently hike rates to tame inflation. It left rates on hold at its last meeting in July, confounding expectations and sending the lira sharply weaker.

It last raised rates in June, when it lifted its benchmark one-week repo rate by 1.25 percentage points, to 17.75 percent.

By signalling that it was ready to take action, the central bank may now have inadvertently set financial markets up for disappointment if it doesn't deliver a hefty increase, said Piotr Matys, an emerging markets forex strategist at Rabobank.

"A proper rate hike is required and by making a pledge to raise interest rates, the central bank may have raised the bar for itself to exceed expectations on Sept. 13," Matys said.

"The central bank basically has no room to disappoint."

'FULL-FLEDGED FIGHT'

The lira briefly recovered some losses immediately after the central bank's announcement. By 1132 GMT it was 1 percent weaker on the day at 6.6100 to the dollar.

President Tayyip Erdogan, a self-described "enemy of interest rates", wants to see lower borrowing costs to keep credit-fuelled growth on track. Economists, who fear the economy is set for a hard landing, want big rate hikes.

Finance Minister Berat Albayrak told Reuters in an interview on Sunday that the bank was independent of the government and would take all necessary steps to combat inflation. He also promised a "full-fledged fight" against inflation.

The bank is likely to deliver an increase of 2 percentage points on Sept. 13, far short of the 7-10 percentage points that investors would like to see, said Jason Tuvey of Capital Economics in a note to clients.

Such substantial increases are needed "to bring real interest rates back to positive territory and reassure the markets that policymakers are willing and able to tackle high inflation," he said.

Inflation jumped 2.3 percent from the previous month, the data from the Turkish Statistical Institute also showed, higher than the 2.23 percent forecast in a Reuters poll.

Producer prices rose 6.6 percent month-on-month in August for an annual rise of 32.13 percent.

A survey released on Monday showed that manufacturing activity contracted for the fifth straight month, as both output and new orders slowed on the back of the currency crisis.

(Editing by Humeyra Pamuk and Toby Chopra)