Analysts assess “early confidence shock” delivered by Turkey’s surprise rate hike

Analysts assess “early confidence shock” delivered by Turkey’s surprise rate hike
In search of more bang from the buck, Mehmet Simsek. / World Economic Forum/Serkan Edeleklioglu.
By bne IntelliNews March 21, 2024

Few analysts predicted the 500-bp rate hike to 50% introduced on March 21 by the Central Bank of the Republic of Turkey (CBRT), but there was a handful of observers who were quite convinced it had to be done.

Deutsche Bank correctly forecast the move and Goldman Sachs Group expected a smaller hike, but all others surveyed by Bloomberg saw no change.

Veteran Turkey watcher and economist Timothy Ash, however, was right on the money, arguing in a note before the rate decision was announced that 500bp would be delivered because “in the end the policy rate [at 45% versus official annual inflation of 67%] is just too low still. Market sentiment seems to have turned against Turkey again and there needs to be an early confidence shock. It seems as though the only choice now is for the CBRT to provide a positive confidence shock—and I think they will move to hike policy rates by up to 500bps this week.

“The value of this hike will be multiplied as I think few in the market expect such a hike this side of the local elections [scheduled for March 31]. Such a move will send a very clear message that [finance minister Mehmet] Simsek and the CBRT have a strong mandate to fight inflation and are able to further tighten policy as needed—pushing back on the narrative that [President Recep Tayyip] Erdogan has set red lines on rates and is tying the central bank’s hands behind its back.”

Ash added that he thought the post-election period will bring further policy tightening, both fiscal and monetary. “As seasonal factors begin to bring improvement on the current account front this should help begin to improve sentiment and stabilise Turkish markets. Base effects should begin to help the inflation narrative in the second half of the year,” he also said.

An objective of the Simsek-led economic reform team is to trigger substantial foreign portfolio inflows that would help dig Turkey out of its economic crisis.

In his note, Ash observed how “TURKGB [Turkish government bond] yields had prior been distorted by various macroprudential measures run by the prior unorthodox [economic] team, but around the 30% mark just did not suggest value/protection enough for foreign institutional investors given high inflation, a persistently high current account deficit and still depreciation pressure on the lira. Some foreign portfolio flows came but just not enough to create the virtuous cycle the reform team needed.”

Following the rate hike announcement, Gordon Bowers, an analyst at Columbia Threadneedle Investments, was cited by Bloomberg as, in a reference to how Erdogan is renowned for suddenly firing central bank governors, saying: “Now assuming CBRT Governor [Fatih Karahan] survives in his post until Saturday morning, I think foreign portfolio flows will soon be returning to Turkey.”

At Bloomberg Economics, economist Selva Bahar Baziki, commented on how the CBRT had also hiked the spread over the policy rate in its overnight lending channel to 300bp from the previous 150bp.

Said Baziki: “We see today’s move to double the interest rate corridor as the central bank making room for an emergency tool to be employed in the final days leading up to the March elections — especially if the lira depreciation deepens. As such, in the case of the inflation outlook worsening, we don’t think the decision rules out an actual lift in the policy rate after the vote.”

In another post-announcement note to investors, Liam Peach at Capital Economics said the CBRT’s “hawkish communications leave open the possibility of another rate hike in April. With the potential for a faster pace of lira depreciation after the local elections at the end of this month and the recent run of strong inflation figures likely to continue, we now expect at least a 250bp hike next month too.”

He added: “We were among the majority of analysts that had expected rates to remain on hold today. We had warned that the tightening cycle was likely to restart following the release of stronger-than-expected inflation figures in January and February, but thought that tightening would resume once the local elections were out of the way.

“It is unclear why the central bank had not flagged today’s move in advance, particularly considering that it has burned through billions of dollars of FX reserves in recent months to stabilise the lira. From that perspective there are some question marks. But even so, the decision to respond so quickly to the recent strong inflation figures and hike rates before the local elections is clearly a very encouraging signal for the policy shift.”

Piotr Matys, the senior FX analyst at InTouch Capital Markets in London, was reported by Reuters as saying that the rate hike “stunned the market”, adding: “Today’s decision is a very strong signal that Governor Karahan, who took over from [Hafize Gaye] Erkan when she unexpectedly resigned, is determined to bring staggeringly high inflation under control.”

Reuters also reported the response to the hike of Stuart Cole, chief economist at Equiti Capital London.

Near 70% inflation and the falling lira, said Cole, “probably forced the central bank to make this move, even though it said just a couple of months ago that it had finished its tightening cycle."

"Probably also at the back of the central bank's mind were the forthcoming local elections. The lira dropped by about 6%/7% after the presidential elections last year and it was maybe worried about seeing something similar this month, and particularly so given that the lira is already struggling."

Turkey's international sovereign bonds extended their rally after the CBRT delivered the largely unexpected rate increase.

The 2038 bond saw the biggest gains, moving up 2.1 cent to trade at 95.768 cents on the dollar, Tradeweb data showed.

Prior to the rate move, Turkey bonds were up around about 1 cent. That reflected more widespread gains across emerging market fixed income following the US Fed advising that future rate cuts remained on track.