A plunging lira may force Turkey’s central bank to raise interest rates for the first time in almost three years.
While the majority of economists in Bloomberg surveys predict the bank will hold its three main interest rates at its next meeting today, seven of 24 polled for the one-week repurchase rate expect at least a 25-basis-point increase – the most dissenters since December. The regulator began its current easing cycle in March, and hasn’t raised rates since January 2014.
The bank has faced constant pressure from government officials for lower borrowing costs, even during times of market turbulence including the aftermath of July’s attempted coup. That’s led many economists to rule out the possibility of a rate increase, but the lira’s decline is changing the political rhetoric, according to Burak Kanli, chief economist at Finans Invest in Istanbul.
“An increase – whether 25 basis points or 50 basis points – implies that the central bank has the option to raise rates, even if the government is reluctant to do so,” Kanli said, adding that improved ties between officials and governor Murat Cetinkaya may have earned the central bank a green light to raise rates when necessary. “That would therefore be positive for the lira.”
Prime Minister Binali Yildirim said on Tuesday he thought the bank would take action on the lira’s volatility, which he described as driven mainly by global developments. Expectations of stronger inflationary pressure and higher interest rates in the US, combined with an emerging market selloff since Donald Trump’s election victory, have driven down the lira, making it the second-worst performing major currency tracked by Bloomberg in the period.
The question is just how big an impact a rate boost would have. The one-week repo – currently 7.5% – is bracketed by overnight lending and borrowing rates at 8.25% and 7.25% respectively in Turkey’s so-called interest rates corridor. The bank has said since last year it plans to bring the rates closer together to simplify and improve monetary policy.
Under the current setup, the bank issues funding under the different rates to adjust daily the cost of liquidity it provides to commercial lenders. If it maintains the existing ratio, a 25-basis-point boost to the one-week repo would see the cost of central bank funding – 7.87% as of November 21 – rise by about half of that, or 12-13 basis points.
That implies that it would need a 50-basis-point increase to the repo rate – taking it to 8% and above the average cost of funds earlier this week – to support the lira, according to Enver Erkan, a Kapital FX economist in Istanbul. To do so would require significant political support, he said. Leaving the overnight lending rate unchanged, even with a higher repo rate, would also make it no more expensive for investors to bet against the currency by borrowing lira in the swap market and selling them in the spot market.
Recent public statements have also shown that senior officials aren’t all on board with higher rates. Presidential adviser Bulent Gedikli said that raising borrowing costs wouldn’t benefit the economy, echoing remarks by Economy Minister Nihat Zeybekci and Deputy Prime Minister Nurettin Canikli.
But with the lira trading at record lows on Friday, Turkey’s top economic policy board – including Cetinkaya – held a surprise meeting in Ankara, stating that the central bank will take any measures necessary to control inflation. Even a “symbolic” rise may reassure investors that policy makers aren’t sitting on their hands, Odeabank economist Sakir Turan said by phone on Friday, adding that he expects the repo gauge to go up by 25 basis points.
“Such an increase would be a clear signal to the market – that the bank isn’t entirely comfortable with the currency’s fall, its impact on inflation and that it is capable of defending against extreme volatility,” he said.
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