By Yeliz Candemir

ISTANBUL--The Turkish central bank Tuesday held interest rates steady, surprising economists who had expected an increase, suggesting that the policymakers refrained from tightening monetary policy as the economy contracted in the third quarter.

The Monetary Policy Committee in Ankara said it kept its benchmark one-week repo rate at 8%. The central bank held the overnight lending rate at 8.5% and overnight borrowing rate at 7.25%.

Ten economists surveyed by The Wall Street Journal forecast that the benchmark one-week repo rate would be raised either to 8.25% or 8.50%, while nine had expected the overnight lending rate to be increased either by 0.25 or0.50 percentage point, while one expected no change. All forecasters surveyed predicted the overnight borrowing rate wouldn't change.

Turkey's lira reversed earlier losses against the dollar to trade 0.1% higher at 3.5240, after the currency weakened to as low as 3.54 against the dollar following the decision. The main BIST 100 stock index was up 0.7%, while the benchmark two-year government bond yield was steady at 10.89%.

Turkey's central bank raised interest rates in November for the first time in almost three years to stem the slide in the Turkish lira. However, the central bank's move couldn't help to ease the downward pressure on the currency.

Turkey's lira has weakened significantly since the summer's failed coup attempt. It has also slumped 12% against the dollar since the U.S. elections, in line with a broader selloff in emerging-market currencies. The plunge was also driven by rising security threats by Islamic Stateand Kurdish insurgents, domestic political uncertainty and expectations of further rate increase from the U.S. Federal Reserve after it raised interest rates by 0.25 percentage point at its December policy meeting.

The central bank's rates decision came a day after the assassination of the Russian ambassador to Turkey during an art opening on Monday night, which both Russian and Turkish policy makers deemed an act of terror.

The U.S. on Tuesday closed its three main missions in Turkey after a Turkish man fired shots outside its embassy in Ankara. And on Saturday, a car bombing in Turkey killed 13 soldiers, less than a week after twin bomb blasts claimed 44 lives outside a soccer stadium in Istanbul.

While the central bank aims to control inflation, the country's economic growth contracted for the first time in seven years during the third quarter. Gross domestic product for July through September shrunk by 1.8% annually, as mounting uncertainties since the failed coup curbed domestic demand and hit the country's tourism industry.

"Exchange rate movements due to recently heightened global uncertainty and the increase in oil prices pose upside risks on the inflation outlook," the Turkish central bank said in a statement. "Developments will be closely monitored in order to make a sound assessment regarding the net impact of these factors."

Turkey's annual inflation rate slowed to 7% in November from 7.16% in October. A monthly survey released by the central bank last week showed that year-end inflation expectations was 7.69% in December, significantly above the central bank's official inflation target of 5%.

"We expect the tightening cycle to resume next year," said William Jackson, a senior emerging markets economist at Capital Economics. "For one thing, the economy should return to positive growth as the impact from July's coup attempt fades. More importantly, the lira is likely to come under renewed pressure next year as the US Fed raises interest rates"

Write to Yeliz Candemir at yeliz.candemir@wsj.com

(END) Dow Jones Newswires

December 20, 2016 09:29 ET (14:29 GMT)

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