UPDATE 1-Turkish govt piles more pressure on central bank over interest rates
* Economy Minister says high interest rates contributing to inflation
* Says criticism not an effort to pressure central bank
* Echoes PM Erdogan who strongly opposes high borrowing costs
* Finance Minister defends central bank fight vs inflation (Adds market reaction, Simsek comments)
By Seda Sezer and Ebru Tuncay
ISTANBUL, May 28 (Reuters) - Turkish interest rates are too high, contributing to inflation and undermining growth and employment, Economy Minister Nihat Zeybekci said on Wednesday, adding to recent government criticism of the central bank.
The political noise over interest rates has undermined confidence in the central bank and added to pressure on the lira, which slipped to 2.1083 against the dollar by 0925 GMT from 2.0979 late on Tuesday.
"We think interest rates are high, higher than the levels they should be at," Zeybekci told reporters at an industry conference in Istanbul.
"Markets are pushing market interest rates down ... The central bank should lead the market trend, not follow the market from behind," Zeybekci said, arguing that high borrowing costs were contributing to rising inflation.
Prime Minister Tayyip Erdogan said two days ago that the central bank's surprise interest rate cut last week, which followed a huge rate hike in late January, did not go far enough.
Speaking separately on Wednesday, Finance Minister Mehmet Simsek defended central bank efforts to tame rising prices but also said inflation was likely to peak this month, reinforcing expectations that the bank could again lower rates.
The comments from Erdogan and others have added to concerns about government interference in monetary policy.
But Zeybekci denied that the government was trying to influence policy.
"I don't think we are putting pressure on the central bank by expressing our worries here," he said.
Last week the central bank cut interest rates for the first time in more than a year, unwinding some of January's huge rate hike aimed at halting a dramatic slide in the lira amid an emerging market sell-off.
Erdogan and Zeybekci's view that high interest rates lead to inflation are contrary to the opinion of most economists, who argue that Turkey's stubborn inflation is largely imported, driven by a weak lira and a heavy trade deficit.
"Zeybekci does himself no favours with investors by again backing his prime minister by arguing that high interest rates contribute to inflation," said Timothy Ash, head of emerging markets research at Standard Bank in London.
"The AK Party government have something of a bee in their bonnets about this ... Most economists, and central bankers, would argue that the causality is the other way around, but it does show the dominant thinking within the AKP."
SIMSEK DEFENDS CENTRAL BANK
Erdogan, who has dominated politics for more than a decade and overseen a period of unprecedented growth, is keen to maintain his record on the economy ahead of an expected run in the country's first direct presidential election in August.
"The question ... is whether commentary from Erdogan and some of his ministers is just meant for domestic consumption ... and driven by the electoral calendar, or the sub plot is to actually pressurise the central bank to cut rates," Ash said.
Speaking in Istanbul, the finance minister appeared to defend the central bank by stressing that its credibility was vital to Turkey and that it should be backed in its efforts to tame rising prices.
"I believe that the central bank must be strong in its fight against inflation, and we need to support it," Simsek said.
But he also forecast inflation would top out this month, boosting expectations that the central bank might loosen policy again at its rate-setting meeting in June, which could leave Turkey vulnerable in the eyes of some investors.
"We have always viewed appropriately high interest rates (c.10 percent) as the necessary and sufficient condition for Turkey's CAD (current account deficit) to remain reliably financed through coming years of progressively less easy monetary policy," Commerzbank said in a note to clients.
"This defence worked, as expected, recently when the central bank hiked rates in an emergency meeting. But, this defence could be about to be dismantled," said the bank, which recommended investors cut their exposure to Turkey in the coming week.
Turkey's 10-year benchmark bond yield rose to 9.35 percent from 9.23 percent at Tuesday's close. The Istanbul share index rose 1.2 percent, outperforming the broad emerging markets index. (Additional reporting by Dasha Afanasieva; Writing by Nick Tattersall; Editing by Hugh Lawson)
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