ING expects the Central Bank of the Republic of Turkey (CBRT) to hike its effective policy rate from 19.25% to 21% when its monetary policy committee (MPC) meets on September 13 and assesses the stark weakness of the Turkish lira (TRY) and a further deterioration in the inflation outlook.
Despite lingering market anxiety that President Recep Tayyip Erdogan has taken control of monetary policy under the beefed up executive presidency he commenced in July analysts are generally not expecting the autocratic Turkish leader—who is notoriously averse to monetary tightening—to stand in the way of the MPC bringing in an interest rate increase. However, the course of Turkish rate-setting has become so unpredictable in the past year that some observers will be hardly shocked if the central bank sticks to its current rates.
The TRY has this year nosedived to its lowest level since the 1994 Turkish economic crisis in real effective exchange rate (REER) terms, while bond yields are at their highest since the 2008 global financial crisis. Annual inflation, meanwhile, stands at a 15-year high of 17.9% and many economists expect it to increase towards 20% in coming months, while Turkey slides into recession and stagflation.
ING concluded in a note: “Given the large FX debt service requirement of the economy—as overall external financing needs remain high with low reserve adequacy—the authorities should be quick to act with credible measures to restore confidence. Accordingly, the policy reaction of the government and the central bank will be key for the stabilisation of domestic financial markets.”
“We expect the CBRT to deliver”
The bank noted that the MPC took no action in July “due to a moderation in economic activity with milder demand conditions and as it awaited the lagged impact of earlier policy tightening and fiscal policy measures. But we expect the CBRT to deliver this month by hiking the policy rate to 21%, with a measured recalibration of monetary policy in a response to the ongoing weakening in the currency and further deterioration in the inflation outlook. We also expect the bank to maintain its commitment to deliver more policy action after the release of the MTP [medium-term programme] to help restore confidence.”
Although during August the CBRT did not introduce any direct rate hikes, it responded to the plunge in the TRY August by tightening liquidity via shifting funding from the one-week repo auctions to the upper band of the interest rate corridor, with a consequent 150 basis point rise in the effective cost of funding to 19.25%. The bank also took some other “low-level measures”, including adjustments in reserve requirement ratios and changes in coefficients of the reserve option mechanism.
“At the September MPC meeting, we expect the CBRT to hike its policy rate (one-week repo) by 325 basis points to 21% while also returning to full funding from weekly repo auctions,” ING said.
Timothy Ash at BlueBay Asset Management is one analyst who feels the Turkish central bank has blown its credibility on monetary policy.
In a September 11 note, he wrote: “I guess if the CBRT was trusted at all, and had any credibility, looking at the macro, with a hard landing under way, and aggressive rebalancing now, we might say we could understand if they did not hike. But this decision is about trying to hold the lira, and keep portfolio investors invested, and ensure FX debt roll-overs from foreign banks. If the CBRT does not show some orthodoxy now, I think the danger is that the latter two groups just throw in the towel and say, given this level of unorthodoxy from the CBRT, I think the danger is people come to the conclusion that Turkey is un-investible.”
He added: “I think if the CBRT delivers a couple of hundred of bps in hikes, the market will give them the benefit of the doubt (playing then to the re-balancing script), that's why I get to something around the 20% for the base rate. It would be better for the CBRT to do more, not less, that would stabilise the lira, and they might actually then be able to cut rates this side of the local elections. If they do nothing, again, then all bets are off.”
Societe Generale sees 150 bp hike
According to Societe Generale, the central bank will likely restore its one-week repo rate as its main policy instrument and hike it to 20.75%. That would mean a 150 bp increase in the effective funding rate, Societe Generale analyst Phoenix Kalen said in a note to clients.
“Although this amount of monetary tightening may disappoint market expectations and spark renewed TRY weakness, the decision would reflect the prioritization of Turkish authorities’ concerns regarding a rapidly decelerating economy,” Kalen added.
Kalen forecast that following the MPC meeting, the central bank’s overnight borrowing rate would be 19.25%, its overnight lending rate would stand at 22.25% and its late liquidity window lending facility would be 23.75%.
“Ideally, the effective funding rate should be around 24%, or 3 percentage points higher than the estimate inflation rate of 21%,” he added.
In a note on inflation, ING added: “Despite relatively benign food inflation—mostly on the back of unprocessed foods—the latest August data presents a bleak picture, with general upward pressure across various sub-components, accelerated further by a sharp TRY depreciation as well as administrative price adjustments. Looking ahead, we expect inflation to increase further towards the 20% handle as the lira's depreciation continues to work its way through to prices. The performance of the Turkish lira and food prices will be key drivers of CPI.”
The bank also noted: “Inflation expectations over 12- and 24-months have trended upwards in recent years to a near record, with the former hitting 12.96% and the latter at 10.67%. A further deterioration would create additional pressure on the real policy rate.
“On the flip side, the ex-ante CBT funding rate is high by emerging market standards, slightly above 6 percentage points as of the end of August. But a further deterioration in the risk attitude towards Turkey in the face of the current inflation uptrend, along with other ongoing macro vulnerabilities, point to the importance of keeping the rate buffer strong.”