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The Central Bank of the Republic of Turkey (CBRT) shrugged off fresh government pressure for an interest rate cut on August 16 to leave its benchmark corridor untouched as it continues to take a cautious stance over inflation. However, CBRT Governor Erdem Basci suggested a narrowing of the band could be on the way soon.

The CBRT held its benchmark one-week repurchase rate at 5.75%, and the top rate for overnight loans at 11.5%. Basci began using the twin limits last year in a bid to help balance sticky inflation, a slowing economy and a struggling currency.

The central bank did, however, raise the proportion of lira reserves lenders can keep in foreign exchange by 5 percentage points to 60%, while reserves permitted to be held in gold rose by a similar margin to 30%. That change stands to add as much as $7.3bn to Turkey's foreign exchange reserves and increase liquidity in the market by TRY5.6bn ($3.1bn), the bank said.

Basci has faced severe criticism from government officials for being "over cautious" in recent weeks, and Economy Minister Zafer Caglayan again called for stimulus via a cut to the top end of the corridor in the hours ahead of the announcement. However, the CBRT governor stood firm, given the resumed rise in the oil price and the spike global food prices due to drought-hit harvests in the US, Russia and other major producers, including Turkey itself.

However, the central bank also said it may narrow the band "gradually in the coming period." The market took that as a sign that Basci won't be able to hold out against the pressure forever, and yields on two-year benchmark sovereign debt promptly saw their biggest drop since March.

Reviewing the country's first -half economic performance on television, Caglayan had claimed GDP growth will be driven by exports this year, adding that the government forecasts the current account deficit will decline to as low as 7.7%.

The pressure on Basci has been building over the last few months as inflation has been tempered by falling domestic demand. However, the CBRT continues to forecast inflation for 2012 1.2 percentage points above its target of 5%. Price rises accelerated to 9.1% in July, which was a drop from the 11.1% recorded in April.

However, analysts at TEB point out that the language used by the CBRT was "cautiously accommodative," and suggests easing is likely on the way sooner rather than later. "The CBRT's assessment on economic activity was broadly unchanged and the bank argued that aggregate demand conditions supported disinflation. Inflation was seen to follow a downward course, as envisaged in July inflation report."

While Basci was careful to say that the central bank is watching prices closely as inflation will continue to stay above the target for some time, the point out, "the statement also said that due to the ongoing uncertainties regarding the global economy, it would be appropriate to maintain the flexibility of the monetary policy on both directions."

All in all, TEB says it is left anticipating a cut for the corridor ceiling by 1 percentage point to 10% in September, although flexibility remains paramount in order to keep a lid on currency appreciation and maintain the ability to respond to global developments and the actions of other central banks.

"Today's decisions hint that [the Turkish lira] funding policy is likely to remain loose in the coming period," the analysts write, "and as a result, overnight money market rates are set to remain at around 5%. The CBRT wants to avoid further appreciation of [the lira]. The favourable short-term inflation outlook and slower growth prospects strengthen the CBRT's hand to adopt a looser monetary policy. At the same time, by maintaining the policy flexibility, the CBRT stands ready to act in case of negative developments on inflation and/or weakening in global risk appetite.

"The latest policy easing of other [emerging market] central banks has provided some room for the CBRT to lower the interest rate corridor, however for further cuts to the ceiling rate, sustained capital inflows would be necessary. As some sort of [quantitative easing] from either the [Federal Reserve] or the [European Central Bank] could lead to such inflows, we continue to see the width of the interest-rate corridor closely linked to the policy actions of the major central banks."