Türkiye's central bank chief on Tuesday cautioned about the impact of the fallout from the Iran war on its fight against inflation, noting that in such situations it is a "natural choice" to turn to gold-based transactions to support liquidity.

Central Bank of the Republic of Türkiye (CBRT) Governor Fatih Karahan said the monetary authority would maintain the needed tight policy to continue the disinflation process.

Annual inflation was 31.5% in February after a gradual decline from 75% in 2024, the year in which the CBRT began slowly cutting rates. But expectations have risen amid the war, largely due to soaring global energy prices.

In response, the central bank has halted its easing cycle with the main rate at 37%, lifted its overnight rate by about 300 basis points to near 40%, and undertaken sales and swaps of foreign exchange and gold reserves to support the Turkish lira.

In the last two weeks, the bank began swapping or selling billions of dollars worth of gold reserves, marking its most aggressive use of the precious metal since 2018.

The CBRT has doubled its gold reserves that were 377 tons back in 2016, Karahan said on Tuesday. As of this month, the share of its gold reserves in total reserves exceeded 60%.

"Therefore, using gold-backed transactions during periods when foreign exchange liquidity needs to be supported is a perfectly natural choice," Karahan told Anadolu Agency (AA).

He said it's not a correct approach to assess such transactions with a mere profit-loss perspective. "Our priority is financial stability and policy effectiveness," he stressed.

'Proactive' approach

The CBRT is pursuing a "proactive, flexible and controlled" approach to its reserve-management and liquidity tools, Karahan said. "The objective of all the steps we take is to support price stability and reinforce financial stability," he added.

Karahan said the pressure on reserves emerges as a natural outcome of changes in the global risk appetite. In this context, he said they are taking measures to limit the impact of this risk aversion on the inflation outlook. "With the outbreak of war, we began funding at the upper band," he noted.

The central bank started to conduct lira-settled foreign exchange forward selling transactions with residents and brought forward its bond purchases to prevent a possible outflow from money market funds.

"These measures have helped maintain the attractiveness of the Turkish lira in domestic markets. While there has been a moderate domestic demand for gold and foreign currency during this period due to falling gold prices, residents' foreign exchange demand has remained limited compared to previous stress periods," said Karahan.

"I would like to reiterate that we are facing an external situation which adversely affects our fight against inflation."

The ongoing tensions in the Middle East, according to Karahan, have driven a sharp rise in energy prices, adding cost-push pressure on inflation and indirectly affecting prices across sectors.

In the medium term, he said the war is expected to have further side effects on inflation; cost- and supply-side disruptions already creating additional pressures.

But he stressed policymakers are "determined to ensure the tightness required for the continuation of the disinflation process."

FX-based lira swap transactions

Karahan and Treasury and Finance Minister Mehmet Şimşek will discuss their strategy on Wednesday and Thursday with foreign investors in London, where Barclays is hosting both group and one-on-one events, bankers said.

One investor who is attending said they will likely face questions about monetary policy given Türkiye's heavy reliance on energy imports and about the central bank's ability to sustain the slow rate of lira depreciation. The investor declined to be named.

In its latest step, which aims to give lenders flexibility managing liquidity, the central bank restarted foreign exchange-based lira swap transactions with buyside auctions worth $10 billion on Tuesday.

To curb price hikes, authorities earlier this month introduced a "sliding-scale" system, which adjusts the special consumption ​tax (ÖTV) on fuel products and prevents higher oil prices from being fully passed through to consumers.

Karahan said their calculations showed the system reduces the impact of oil prices on inflation to one-third.

He still stressed analyses that he said indicate that a permanent 10% increase in oil prices adds approximately 1.1 percentage points to consumer inflation over a year.

"So far, we have promptly introduced measures to reduce inflationary effects. Currently, uncertainties remain as to the course of the war," Karahan said.

"We will ensure the tightness required to contain the inflationary effects of the developments through expectations and pricing behavior."

Cooling of economic activity

Karahan went on to say that they expect the rising energy costs, external uncertainties and the resulting potential weakening of external demand to create a downward pressure on economic activity.

And the growing uncertainties will also have an impact on investment appetite and private consumption, he added. "Our analyses suggest that a 10% supply-side increase in oil prices leads to a 0.4-to-0.7 percentage points of decline in the growth rate over a one-year period," he said.

Recent developments, Karahan said, will affect the current account balance diversely through energy and non-energy items.

"Our analyses show that a $10 increase in oil prices deteriorates the one-year net energy balance by approximately $3 billion to $4 billion. In case of a parallel rise in natural gas import prices as well, this impact may go up to $5 billion," he said.

Regarding non-energy items, Karahan said a potential moderation in global demand would have an upward effect on the current account deficit through exports and tourism. "However, cooling of economic activity will affect the trade balance favorably," he noted.

The level of the current account deficit is currently below its historical average, he added. "We think that the possible deterioration of the current account balance amid recent developments will be manageable."