Turkey’s central bank on February 18 kept its key rate at 17.00% as expected by almost all analysts. It was the second time in a row that the regulator left monetary policy parameters unchanged.
Jason Tuvey of Capital Economics said the hawkish tone in the statement [that accompanied the decision to hold the key rate], including a commitment to bring inflation back to the 5% target, confirms our view that an easing cycle will come later and be slower than most currently anticipate. This will help support a new read rally over the next few months.
A cumulative tightening of 675bp has been introduced since Naci Agbal was appointed governor of the Central Bank of the Republic of Turkey (CBRT) in early November, when President Recep Tayyip Erdogan also replaced his Minister of Economy and said his administration was ready to swallow the bitterness. This was taken as a reference to the president, who is notoriously opposed to interest rate hikes even in the face of high inflation (indeed, Erdogan argues that high rates cause inflation), stepping back from his so-called Erdoganomics to allow the central bank to switch to orthodox economic policy, using rate hikes to fight inflation. The Erdogans’ change of course came with the economy apparently poised to plunge into its second balance of payments crisis in two years.
Annual inflation in Turkey now officially stands at around 15%, although some academics have questioned the methodology used by state statisticians to reach this figure, claiming that Turkish inflation is actually much higher.
Reduction of the risk premium
Tuvey added: Policymakers will also have welcomed the continuation of the rally in the lire over the past month, with investors confident that the shift to orthodoxy will continue. The currency is now up about 20% against the dollar from its November low and is by far the best performing emerging market currency since the start of this year. The appreciation of the liras was supported by a reduction in the risk premium demanded by investors to hold Turkish assets, characterized by a sharp tightening of bond spreads in dollars.
At the same time, there are growing signs that Turkey’s economic recovery has weakened in recent months. The latest activity data shows that while the industry held up well in December, retail sales fell amid the country’s second wave of COVID-19.. And the tightening of monetary conditions in the second half of last year resulted in a sharp slowdown in credit growth.
Tuvey also noted that Erdogan had not given up on his unorthodox views on monetary policy and that he could yet turn around and try to force the CBRT to change course and cut rates. For now, however, we are confident that orthodox monetary policy will remain in place for the foreseeable future and that the central bank will keep interest rates high in order to bring inflation down.
Capital expects the benchmark one-week repo rate to remain at 17.00% throughout 2021. In contrast, the consensus is for 375bp of rate cuts by the end of the year. If it had been right and geopolitical tensions continue to melt, the rallye des lire probably has more to run. We expect it to end this year at $ / $ 6.25, Tuvey said.
The CBRT’s Monetary Policy Committee said after its rate-setting meeting: Tight monetary policy will be decisively maintained … for an extended period until strong indicators point to a permanent decline inflation and price stability. Further monetary tightening will be provided if necessary.
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