Turkish rates kept on hold as widely expected, market likes decision

Turkish rates kept on hold as widely expected, market likes decision
By Akin Nazli in Belgrade October 25, 2018

As widely expected, the rate-setters at Turkey’s central bank on October 25 opted to keep the national lender’s policy rate at 24%.

Responding to the decision, outlined in a press release from the central bank’s Monetary Policy Committee (MPC), Timothy Ash of Bluebay Asset Management said in a note to investors: “No change—no surprise. All focus on October CPI [with the latest consumer price inflation data to be announced on November 5] for the main act.”

He added: “On [the October CPI figure] there is zero clarity on what it might be: a) The CPI – PPI gap suggests lots more pass through to come versus b) the newfound lira strength, plus recession/deflationary conditions and the government gaming the inflation series with its new Inflation Plan will see a surprisingly benign print. The range likely is 25-30%!”

By “gaming” the analyst was referring to the October 9 announcement that Turkey has signed up its private sector in the country’s fight against runaway inflation—businesses agreed to voluntarily cut 10% from prices for two months, while banks said they would apply a 10% discount to interest rates for loans provided after August 1.

Following the MPC decision to keep its policy rate (the one-week repo auction rate) constant, the Turkish lira (TRY) had as of around 17:45 local time strengthened 1.23% d/d against the USD to trade at 5.6306. The TRY has lost around a third of its value against the dollar in the year to date.

“[The central bank] leaves rates unchanged, as expected by the market, and the market is liking it, with the lira rallying,” Ash added in a tweet.

“In line with our expectations... the central bank may want to wait and see what are the lagged effects of their bold action [in going for a major 625 bp hike] on September 13 and the inflation targeting plan,” Nora Neuteboom of ABN Amro Bank said in a tweet. ABN Amro Bank expects consistently high inflationary pressures in the coming months, Neuteboom previously said on October 23 in a research note.

“The central bank’s decision to leave interest rates unchanged today and the accompanying statement reinforce our view that last month’s aggressive rate hike didn’t represent a shift back to [monetary policy] orthodoxy. Interest rates are unlikely to be raised further. Indeed, the bigger risk in our view is that, with President [Recep Tayyip] Erdogan starting to raise pressure for lower interest rates, that policy is loosened prematurely,” Jason Tuvey of Capital Economics said in an emailed comment entitled “Turkey: further rate hikes unlikely to materialise”.

Three key factors
There were three key factors that were likely to have swayed the central bank towards leaving interest rates unchanged, according to Tuvey. The first was the rally in the lira which has improved its standing by around 20% against the USD since the beginning of September, driven by an improvement in investor sentiment following last month’s aggressive rate hike and signs that Turkey’s political relations with the US are improving. The second was mounting evidence that the economy is entering a deep recession. Third, there was likely to have been a lot of political pressure on the central bank not to raise interest rates any further, Tuvey said.

Capital Economics expects inflation, recorded at 24.5%in September, to rise a bit further over the coming months. “But unless that is accompanied by another sharp sell-off in the lira, it probably won’t be enough to prompt additional rate hikes. Even if the central bank did feel that further tightening is warranted, past experience suggests that it would most likely be delivered through the interest rate corridor. The bigger risk is that mounting political pressure on the central bank prompts interest rates to be cut prematurely, perhaps as soon as early next year when headline inflation will start to drop back,” Tuvey added.

“If they signal an easing on monetary policy [in the time] until the end of the year, the lira is at great risk of experiencing another wave of weakness, another sell-off,” Per Hammarlund of SEB told Reuters.

“Given the marked deterioration in price-setting behaviour as observed by the big inflation surprise in September and forward-looking expectations, a further adjustment in monetary policy to push the ex-post real policy rate back to positive levels should not be ruled out,” Muhammet Mercan of ING Bank previously observed, on October 22, in a research note.

More noticeable rebalancing
“Recently released data show that the rebalancing trend in the economy has become more noticeable. External demand maintains its strength while the slowdown in economic activity continues, partly due to tighter financial conditions,” the MPC said in its press release.

It added: “Recent developments regarding the inflation outlook point to significant risks to price stability. Price increases have shown a generalized pattern across subsectors, reflecting the movements in exchange rates. Although weaker domestic demand conditions will partially mitigate the deterioration in the inflation outlook, upside risks on the pricing behaviour continue to prevail. Accordingly, the Committee has decided to maintain the tight monetary policy stance.”

The MPC said it would closely monitor inflation expectations, pricing behaviour, the lagged impact of recent monetary policy decisions, the contribution of fiscal policy to the rebalancing process, and other factors affecting inflation. If needed, the rate-setters would deliver further monetary tightening, it added.

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