Nicholas Watson in Prague -

After the Hungarian central bank took the surprise decision on Wednesday, October 22 to hike interest rates by 300 basis points in a move designed to support its plummeting currency, the question then became, who would be next? Romania or Turkey rather than Poland or the Czech Republic was the consensus; as it turned out, Turkey's monetary authorities decided to keep the key policy overnight borrowing rate constant at 16.75% the following day.

Certainly, the fall in the Turkish lira has resembled the Hungarian forint's steep downward trajectory. From 240 forints for every euro a few weeks ago, the EUR/HUF had fallen to 280 before Wednesday's move, which helped it recover to around 275. The Turkish lira has lost around a quarter of its value against the dollar in the last month as investors flee countries like Turkey and Hungary, with large current account deficits, which are teetering on the brink of financial collapse and in need of International Monetary Fund money.

The impact of the decision by the Turkish central bank to keep rates on hold came as no surprise - the lira fell to a 28-month low against the dollar, easing more than 4% to trade at 1.70 levels against the dollar from its Wednesday interbank bank close of 1.63.

Why did the bank take - or not take, as it were - this action on rates? "The [central bank] decision to keep the rates on hold at 16.75% was a very brave one, yet the results have to be seen," says Elif Kucukcobanoglu of ATA Invest.

At issue is a tricky trade-off for the bank: on the one hand the central bank remains under pressure to hike rates from a trade perspective, as it needs to make it more costly to speculate against the lira; but the extra "cost" of this will come from a fundamental perspective as the slowing pressures on the economy will increase. Clearly, the bank has decided that given the main reason behind the recent sell-off in emerging markets is hardly a search for better yield relative to risk, the chances of central banks being successful at protecting their currencies by rate hikes looks pretty limited. "Redemptions in funds are beyond the control of policymakers in emerging markets at this stage and policymakers will mostly need to manage the effects as things slightly settle down in the global markets," says Sengul Dagdeviren of ING in Istanbul. "The [central bank's] move was positive fundamentally, but from a trade perspective it might cause the lira to remain under pressure for some more time."

Furthermore, the central bank said in a statement it believes that falling food prices along with the sharp decline in oil prices will offset any negative impact from the recent exchange rate movements, meaning there will be no major changes in medium-term inflation expectations. "We also believe recent currency weakness will have limited lagged effects on inflation due to the sharp slowdown in domestic demand in the current quarter. Subsequently, we expect the central bank to remain on hold until the global backdrop stabilizes," Kucukcobanoglu said in a note.

The central bank did lower its overnight lending rate from 20.25% to 19.75%, which is regarded as the first step in the bank's plan to pull the market's reference rate from its borrowing rate (16.75%) to its lending rate (19.75%) in the coming period as liquidity is expected to remain tight in 2009, which will eventually correspond to an effective rate hike.

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