Recovery in Turkey’s Real Effective Exchange Rate extends into November

Recovery in Turkey’s Real Effective Exchange Rate extends into November
By Akin Nazli in Belgrade December 4, 2018

Turkey’s CPI-based Real Effective Exchange Rate (REER) index rose from a revised 69.11 in October to 74.59 in November, central bank data showed on December 4.

The REER hit a record low of 61.72 (revised) in September. The Turkish lira’s (TRY’s) weakest ever level against the dollar, namely TRY7.24, was recorded on August 23 as factors including Turkey’s economic imbalances combined with a deterioration in relations with the Trump administration.

The index stood at 85.19 at the end of 2017. In January, it edged up to 85.87 but consecutive declines, which gathered pace, were then seen across the following eight months. The first all-time low level seen this year occurred in March.

Notably, the October reading is still below July’s 75.99 (revised).

A higher REER points to the lira gaining value in real terms against foreign currencies while a decline in the index indicates it has lost real value.

The TRY was trading at 5.4158 against the USD, weaker by 3.22% d/d, as of 17:15 Istanbul time on December 4. But an index of emerging market peers climbed on the day to the strongest in almost four months, with 22 out of 24 currencies strengthening, Bloomberg reported.

Growing expectations of premature rate cut
The Turkish currency was trading in the 5.10s only two working days back, on November 30, but it gradually moved into the 5.20s on December 3 and into the 5.30s on December 4 over rising oil prices—Turkey is a big energy importer—and growing expectations of a premature policy rate cut being brought in before the local elections to be held on March 31, 2019.

“Last week, Fed Chair Jerome Powell's ‘dovish tone’ had a positive impact on global risk appetite… This weekend the US and China agreed on a 90-day ceasefire in their trade war. The rising optimism on global markets reflected also in domestic markets and the Turkish lira gained strength…This week’s agenda is quite heavy. The OPEC meeting, in which the roadmap of oil supply will be reshaped, developments in US labour markets and the Brexit deal vote in the British parliament are high on the agenda,” Isbank Research said on December 3 in its weekly bulletin.

“Lira tumbles as traders fret about premature rate cut following better than expected inflation numbers,” Holger Zschaepitz of Welt noted on December 4 in a tweet.

#USDTRY up nearly 4% from last week's low on global risk-off moves, rise in oil prices, worries of premature central bank action,” Fercan Yalinkilic of Bloomberg said on Twitter.

“The main items on the local agenda in December will be the MPC [Monetary Policy Committee] meeting [to be held on December 13], the November inflation, FX interest rate and the 3Q18 GDP growth data [to be released on December 10],” Seker Invest said on December 4 in its strategy note.

“Based on the negative trend in PMI, imports, credit growth, [white goods] and auto sales, consumer and real sector confidence indices, etc., we continue to expect GDP growth to drag into a contractionary phase in 4Q at the latest (or probably from 3Q) until 2H19. We expect 2018 GDP growth at a tad above 2.0%, vs. the 3.0-3.5% consensus view and new economy program’s 3.8% prediction,” Seker Invest said also on December 3 in its macro outlook.

Vehicle sales in Turkey shrank 42% y/y to 58,204 units in November despite tax cuts after plunging 76% y/y in Octoberthe Turkish Automotive Distributors’ Association (ODD) reported on December 4.

“Lira has struggled post the good inflation numbers—and I do sense it’s around concern that the [central bank] will take this as the green light to ease prematurely. The data flow still seems lira supportive on the real economy front, with strongly recessionary data flow suggesting still current account adjustment is occurring apace,” Timothy Ash of Bluebay Asset Management, a devoted lira bull since the beginning of September, said in an emailed comment to investors.

Goldman Sachs has predicted that inflation in Turkey will peak at around 27% in Q1 2019.

But Ash questioned that outlook on Twitter, saying: “Not sure how inflation can peak now at 27% unless we see a policy relapse ahead of local elections in March and the lira takes another leg lower. The watchword is ‘recession’ and that could now mean further downside surprises on inflation.”

“What about some inertia (services?). We also have tax cut reversal (can govt afford to continue extending cuts?) plus cost pressure (latest PMI survey showed erosion of stocks). You’re saying recession pressures strong enough to negate these?” Mark Bentley, a former Turkey bureau chief of Bloomberg, responded to Ash.

“In for a bumpy trip”
“One former policy maker summed it up nicely to me. Turkish economy was like state of the art plane bought on foreign debt. But old experienced pilots had been sacked. New pilots lacked experience—not sure they had read flight manual. So in for bumpy trip,” Ash said also on December 4 in another tweet.

Turkey’s annual consumer price inflation rate in November fell for the first time since March—and sharply. The month saw it fall 3.62 percentage points from October's 15-year high of 25.24% to 21.62%, the Turkish Statistical Institute (TUIK) announced on December 3

“Inflation figures presented a relatively benign picture in November, when currency basket and Brent crude oil prices declined respectively by 8.4% and above 20% mom, in terms of monthly averages. Recent measures taken to fight against inflation and the tax cuts have supported the improvement in inflation. We estimate that CPI will record a relatively slight monthly increase with 0.2% in December, bringing the year-end CPI inflation rate to 21%,” Isbank Research said on December 3 in a note.

“The continuation of discount campaigns and tax incentives till the end of the year could lead consumer inflation to fall further to near 21% in December. Though, likely reversal of the discount campaigns and tax incentives and unfavorable base effects at the start of next year could bring a transitory increase [limited at 2-3pp] in the headline [across Q1 2019]; but given the recent supportive external financial conditions, risks are accumulating on the downside,” BBVA Research said on December 3 in a note.

It added: “November inflation also seems to surprise the Central Bank (CBRT) on the downside, given the more positive external financial conditions than they initially forecasted. Though, still the uncertainties over the likely reversal of the price campaigns and other adjustments at the start of next year should keep the CBRT vigilant and avoid immediate easing cycle before realizing a permanent improvement in inflation and medium term expectations.”

“Not sustainable”

While Turkey’s economy is “rapidly” following the plunge in the lira this year—it is presently around one-third weaker against the dollar in the year to date—and subsequent major rate increases, the slowdown in price rises is also due to unorthodox policy measures and that is not sustainable, Nora Neuteboom of ABN Amro Bank told Bloomberg, adding: ““There is a risk that the central bank may decide to cut rates too soon, say end-first-quarter 2019, when markets are not ready yet, feeding into further volatility of the lira.”

The inflation slowdown is temporary and a more sustained drop in inflation will materialise only from the third quarter of 2019, when the impact of the exchange-rate shock drops out of the calculations, Inan Demir of Nomura told Bloomberg, adding: “However, the Turkish central bank’s reaction function has mostly been about the exchange rate rather than inflation itself. So, even though our baseline sees the policy rate unchanged for a prolonged period of time, we cannot rule out the risk of an earlier cut on account of lira stability.”

“The effects of Turkey's currency crisis and the dramatic rise in interest rates are likely to push the economy into a deeper recession than most expect,” Capital Economics reiterated on December 3 in an emailed note.

“Turkey's one-of-a-kind rebalancing continues in [November] with imports -21%, exports +9% y/y. November will likely be 4th month with a sizable current account surplus which is very unusual. Cumulative [surplus] has probably been in the range of USD7-7.5bn since July. Lira +35% since then,” Emre Akcakmak of East Capital observed on December 4 in a tweet.