How Turkey cut interest rates but didn’t really
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
Turkey gearing up for rate cuts but not today
Could the Turkish central bank surprise markets again today?
Given its track record, few will dare to place firm bets on the outcome of today’s meeting but the general reckoning for now is that the bank will keep borrowing and lending rates steady and signal no immediate change to its weekly repo rate of 5.75 percent. With year-on-year inflation in the double digits, logic would dictate there is no scope for an easier monetary policy.
But there are reasons to believe the Turkish central bank, whose mindset is essentially dovish, is letting its thoughts stray towards rate cuts. Consider the following:
a) Governor Erdem Basci has already said he does not see the need for further policy tightening b)The lira has strengthened 9 percent this year against the dollar and is back at levels last seen in early September, thanks to almost one billion dollars in foreign flows to the Turkish stock market and well-subscribed bond issues. And crucially c) Global factors are supportive (developed central banks are continuing to pump liquidity and a bailout has finally been agreed for Greece) .
So some analysts are already weighing the likelihood of a pre-emptive rate cut in Turkey. ING analyst Sengul Dagdeviren writes:
Depending on the CBT’s view on capital inflows (ECB LTRO due soon, quantitative easing bias strengthening in G10, and Greece worries diminishing look supportive in that regard), the chance that it could surprise markets by lowering the upper band of the overnight interest rate corridor to 9 percent (down from 12.5 percent) remains.
The key to this will be the lira’s exchange rate.
Can Turkey confound the pessimists again? The numbers say no
Doomsayers have been prophesying Turkey’s economic boom to deflate into bust for many months now. The recent revival in positive investor sentiment worldwide ar has helped silence some voices. Others say it is a matter of time.
Data on Friday showed annual inflation accelerated from last year’s 3-year highs to 10.6 percent in January. It is likely to remain elevated at least until May, analysts predict. And trade data released this week indicate Turkey will likely have finished last year with a current account gap of around 10 percent of GDP last year — the biggest of any major developing economy. All this appears to indicate that the central bank will have to keep monetary policy tight and might even have to even raise rates, should the current resurgence in risk appetite fade. But rather optimistically, the government is still forecasting 4 percent growth this year. The IMF says 0.4 percent is more likely. A report today by Capital Economics, entitled “Turkish boom hits the buffers”, says recession is a cinch.
Neil Shearing, the report’s author, notes that imports of both consumer and capital goods have fallen by around $1 billion over a 12-month rolling period. That indicates a contraction in private consumption and fixed investment, he writes. Some of this could of course be down to the lira’s weakness last year, that aided some import substitution, Shearing acknowleges. But he says that all signs are that:
A combination of tougher external conditions and tighter domestic monetary policy have caused a two-year boom in Turkish domestic demand to come shuddering to a halt. Our base case is for a fresh bout of risk aversion to cause the lira to hit 1.90 per dollar over the next six months, causing interest rates to spike — and the Turkish economy to contract by 1 percent this year
With so large a deficit, Turkey will always remain hostage to the ebb and flow of global risk appetite. But the country has regularly confounded pessimists. The past month has seen the government as well as corporates return successfully to international bond markets, bringing much-needed dollars into the country. The lira has rallied 7.5 percent since the start of the year, recovering more than a third of last year’s losses. Should this continue, inflation will ease and financing the current account deficit will be less of a problem. But many suggest the lira’s days of strength could be numbered — JP Morgan analysts for instance suggest taking profit on some long lira positions. Turkey’s influential export lobby has already started complaining about the lira’s rise, they note.
