Turkey’s central bank kept its policy rate unchanged at 37%, but the decision should not be read as a sign that monetary conditions are about to ease.
The Central Bank of the Republic of Turkey, or CBRT, also maintained its overnight lending rate at 40% and its overnight borrowing rate at 35.5%. The policy rate has now remained unchanged for four consecutive meetings.
The decision reflects a difficult balance. Domestic demand is weakening, which should support disinflation, but higher energy prices, persistent service inflation, exchange-rate risks and domestic political uncertainty continue to restrict the central bank’s room for manoeuvre.
In its statement, the CBRT said the underlying trend of inflation declined slightly in June but could rise temporarily in July. It also noted that energy prices had returned to an upward trend as geopolitical uncertainty increased.
The central message is that weaker economic activity alone may not be enough to bring inflation down quickly.
Inflation is falling, but remains deeply embedded
Consumer prices rose by 0.99% in June from the previous month, while annual inflation declined to 32.11%, according to official data.
The lower annual rate confirms that Turkey remains in a disinflationary phase. But disinflation does not mean prices are falling. It means they are continuing to rise, only at a slower pace.
Part of the annual decline also comes from base effects as unusually large increases from the previous year leave the calculation. The more important test is whether monthly inflation can remain consistently low.
That remains difficult because inflation in rent, education, healthcare, restaurants and other services is relatively insensitive to short-term changes in consumer demand. Prices in these areas are often adjusted according to past inflation, wages and expected future costs.
This backward-looking behaviour makes inflation sticky. Even when spending slows, businesses continue to price in future currency depreciation and higher input costs, while wages and rents are adjusted to recover earlier losses in purchasing power.
The result is an inflation process that can continue long after the original shock has passed.
Expectations remain above the central bank’s path
The CBRT’s July Survey of Market Participants shows that investors expect inflation to decline, but not rapidly.
Respondents forecast annual inflation of 29.21% at the end of 2026, 23.95% over the next 12 months and 17.83% over the next 24 months. The survey also placed end-2027 inflation at 21.47%.
These expectations remain above the central bank’s near-term path. The CBRT has set interim inflation targets of 24% for 2026, 15% for 2027 and 9% for 2028. Its current forecasts place inflation at 26% at the end of 2026 and 15% at the end of 2027, before a projected decline to 9% in 2028.
The gap matters because monetary policy works partly through expectations. If companies and households believe inflation will remain high, they continue to set prices, wages and contracts accordingly.
An early interest-rate cut could therefore weaken demand for the Turkish lira, increase foreign-currency purchases and reverse recent improvements in inflation expectations.
What does the 42% bond yield tell us?
Turkey’s Treasury sold two-year fixed-coupon government bonds at a compound yield of 41.99%. The auction attracted 41.7 billion lira in bids, with net sales of 25.1 billion lira.
The yield was almost five percentage points above the CBRT’s official policy rate.
It would be misleading, however, to conclude that investors expect inflation to remain at 42% for two years. A government bond yield reflects more than expected inflation. It also includes expectations for future policy rates, exchange-rate risk, liquidity conditions, Treasury borrowing requirements, political uncertainty and the term premium investors demand for committing money over a longer period.
Even with that qualification, a yield close to 42% sends a clear signal. Investors continue to price substantial inflation, currency and political risk into medium-term lira assets.
The figure suggests that markets expect nominal interest rates and Turkey’s risk premium to remain elevated even as annual inflation declines.
Higher government borrowing costs also increase debt-servicing expenses. This could complicate fiscal consolidation and leave monetary policy carrying a larger share of the burden of reducing inflation.
Rising oil prices could interrupt disinflation
Energy has again become one of the largest external risks to Turkey’s inflation outlook.
Brent crude rose above $98 a barrel on July 23 as renewed conflict involving Iran and attacks on oil tankers increased concerns over supply routes in the Middle East.
Turkey is heavily dependent on imported energy. Higher oil prices therefore affect not only petrol and diesel but also transport, agriculture, industrial production and food distribution.
The effect becomes more damaging when global energy prices rise at the same time as the Turkish lira weakens. A simultaneous oil and currency shock can quickly pass through to consumer prices.
This creates a problem for the CBRT. Domestic demand may be slowing, but cutting interest rates while energy costs are rising could increase pressure on the currency and reinforce inflation expectations.
Political risk further narrows the policy space
Turkey’s next presidential and parliamentary elections are due by 2028 under the current constitutional timetable. As the election period approaches, investors are likely to pay closer attention to the possibility of stronger credit growth, higher public spending, tax changes or wage measures designed to support economic activity.
Such policies are not inevitable. However, the risk of a shift towards pre-election stimulus can affect borrowing costs and exchange-rate expectations before any measure is formally introduced.
Domestic political and legal tensions have already shown their ability to move Turkish markets. A court decision involving the leadership of the main opposition party in May triggered a sharp sell-off, with the Borsa Istanbul index falling by as much as 6% and government bonds coming under pressure.
When political risk rises, the central bank is no longer managing inflation and domestic demand alone. It must also consider capital flows, foreign-exchange demand, reserve losses and financial stability.
The central bank has no easy option
The CBRT is caught between two competing risks.
A further rate increase would raise borrowing costs, weaken investment and consumption, and intensify the economic slowdown.
A premature rate cut could weaken the lira, revive demand for foreign currency and undermine inflation expectations.
Holding the policy rate at 37% is therefore less a sign of confidence than an indication of limited room for action.
Annual inflation may continue to decline, but the path is unlikely to be rapid or uninterrupted. Persistent service inflation, high Treasury borrowing costs, renewed energy shocks and political uncertainty all point to a prolonged period of tight financial conditions.
The near-42% yield on two-year government debt does not mean inflation will remain at that level. It does show that investors require a very high return to accept medium-term lira risk.
Lasting price stability will require more than interest-rate decisions. Monetary restraint will need to be supported by credible fiscal policy, contained public spending, greater political predictability and a more stable external energy environment.
Until those conditions begin to align, Turkey’s inflation may fall without becoming truly low—and the central bank’s hands will remain largely tied.