How Turkey cut interest rates but didn’t really

February 21, 2012

How do you cut interest rates without actually loosening monetary policy? Turkey’s central bank effectively did that today.

I wrote this morning that the bank and its boss Erdem Basci were gearing for rate cuts, thanks to the lira’s steady rise (see the graphic)  that should help tame inflation later this year (provided the global investment feel remains positive). But I also said a rate cut was unlikely to happen today. I was wrong — and right too. The central bank cut its overnight lending rate by 100 basis points to 11.5 percent while keeping the one-week repo rate  — the main policy rate — steady at 5.75 percent.

So why is this not a real cut? Note that the former overnight rate hasn’t been used for over a month. Instead the central bank has been using the “corridor” between the lending and borrowing rates to adjust policy on an almost daily basis. The upper end of the corridor is in fact used more to tighten policy when there is a need to defend the lira, analysts point out. And most importantly, the central bank has already been providing funds at the cheaper 5.75 percent rate.

Morgan Stanley analyst Tevfik Aksoy writes:

This, in our view, did not come as a surprise, and should not be seen as a significant change in the monetary policy stance….The move, in our view, is not monetary easing but an adjustment to changing conditions…..We think that the difference between 12 percent and 11 percent are sufficiently high to stem currency depreciation in case global sentiment turns sour in coming weeks.

According to economist William Jackson at Capital Economics:

Clearly the central bank’s decision is a nod towards the more favourable external financing conditions

Markets have — correctly —  interpreted the step as a shift to an easing bias.  The lira fell a little against the dollar. Bond yields fell below 9 percent for the first time since October. But the impact for now should be marginal because the “real” interest rate — the one-week repo — remains unchanged.

But if foreign investors’ appetite for emerging markets keeps improving, the lira will resume its appreciation. And that should allow the central bank to cut rates for real in coming months.

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