Turkey dazzles market with additional 500bp rate hike to 50%

Turkey dazzles market with additional 500bp rate hike to 50%
*ENAG is an Istanbul-based independent inflaton research group of economists. / bne IntelliNews
By bne IntelliNews March 21, 2024

The monetary policy committee (MPC) of Turkey’s central bank on March 21 surprised the market by hiking its policy rate (one-week repo rate) by 500bp to 50%. The market had expected the committee to stick with 45% as the headline rate (chart).

Additionally, the authority hiked the spread over the policy rate in its overnight lending channel to 300bp from the previous 150bp.

Lately, the central bank has been pushing local banks (by offering low amounts via its one-week repo channel) into overnight borrowing, effectively lifting its funding rate to 46.5%.

The so-called “interest rate corridor” policy was invented in 2011 by the economy team that back then was made up of the current finance minister Mehmet Simsek, ex-economy czar Ali Babacan and then central bank governor Erdem Basci. The idea was to work around then prime minister Recep Tayyip Erdogan’s refusal to allow rate hikes.

The market remembers it as a “legendary” invention and it has created a big headache when it comes to the credibility of the regime’s monetary policy. However, as the central bank is currently delivering what the finance industry is demanding, the industry sees the additional tightening conducted via the corridor, like all other parts of the new policy, as positive.

In its statement that accompanied its latest 500-bp hike, the MPC noted that the underlying upward trend in monthly inflation in February exceeded expectations.

In response to the deterioration in the inflation outlook, the committee decided to raise the key rate.

Disinflation will be established in the second half of this year, according to the MPC.

In June 2023, following the post-election appointment of Turkey’s new economic team led by Simsek, the Erdogan regime launched a tightening process that is now seen as still ongoing. The 45% policy rate was achieved by January after a series of hikes that pushed it up from the 8.5% at which it stood eight months previously.

At 45%, the authority assessed that the monetary tightness it was seeking to establish a course of disinflation had been achieved, thus it left the benchmark alone at its rate-setting meeting in February.

Come March, the pressure on the USD/TRY pair had increased. Prior to each election—and it is important to note that local elections will take place in Turkey on March 31—the Erdogan administration exerts pressure on the pair. After the polls, it delivers a currency devaluation.

Currently, the finance industry has little Turkish lira to sell, while local institutions are not allowed to sell TRY thanks to non-capital controls that are in effect (lately, some media reports suggested that the central bankers, currently tagged as “orthodox” by the financial media, have been calling banks to question why they were entering FX buy orders).

One thing the regime is unable to do is prevent Turks from boosting their FX demand. And, as a result of the visible pressure mounting on the lira, the finance industry raised its pressure on Erdogan officials for additional rate hikes.

The analysis of this publication is that the latest rate hike will have no impact when it comes to the lira’s woes. Even if the regime offered an interest rate of 500% rather than 50%, the Turks will keep buying FX until the local elections.

They will also remain cold to lira in the post-election period, but the finance industry hopes to bring in some fresh FX.

Although the fever besetting the lira is not curable without some fresh FX inflows, the regime’s additional rate hike was the correct decision. If you want a ride on the finance industry boat, you have to give the industry what it wants.

At the end of the day, if the finance industry is your friend, you will never need an enemy.

Also, when it comes to the regime’s monetary policy, the central bank is applying  more and more macroprudential measures and non-capital controls.

Doing a fair imitation of a parrot, this publication has kept pointing to the little-acknowledged criticism that the so-called “simplification” of Turkey's monetary policy is a deceit. Many in the financial media, meanwhile, have conveniently forgotten the consecutive “simplification” headlines that they advanced of late.

These are classic exercises performed by the Erdogan regime and the mainstream media. You can also recall developments such as the apparent “Chinafication” policy, among others, if they have slipped your memory.

In the coming period, the MPC will still be tracking the official monthly inflation series. The Turkish Statistical Institute (TUIK, or TurkStat) is set to deliver more significant declines in the official monthly headline indicator.

On March 4, TUIK said that its official annual consumer price index (CPI) inflation stood at 67% y/y in February versus 65% y/y in January and 38% y/y in June last year.

TUIK also posted a 5% m/m official inflation reading for February versus 7% m/m for January.

On February 8, the central bank kept its end-2024 official inflation estimate unchanged at 36% in its quarterly inflation report while its new governor, Fatih Karahan, said that the central bank saw the official series peaking at 73% in May.

According to central bank deputy governor Cevdet Akcay, the 36% end-2024 official inflation “target” was ambitious, but the regulator, he said, was setting out to be ambitious.

That tends to suggest that the central bank actually sees the end-2024 inflation figure at a higher level, but is nevertheless keeping to its previous estimate as the target level.

According to Karahan, average official monthly inflation will decline to 1.5% in 4Q24.

On May 9, the central bank will release its next inflation report and updated forecasts.

The monetary policy personnel are also aiming for real appreciation in the lira, which means that the rise in the USD/TRY pair should remain below official inflation. It all depends on the finance industry’s portfolio inflows, as already outlined.

The USD/TRY rate fell from the 32.40s to 31.80s following the rate hike announcement. By the evening, it was very slightly above 32.0. Despite the limited retreat, the annual rise in the pair has risen above the 70%-level.

The market is strictly under the control of the regime. Officials chance their arm at applying pressure on the pair from time to time, but the USD/TRY’s secular trend will not be broken without those significant FX inflows.

Looking at the global markets, as things stand they do not suggest any notable turbulence. Turkey’s five-year credit default swaps (CDS) rose above the 300-level, while the yield on the Turkish government’s 10-year eurobonds remains below the 8%-level.

The next MPC meeting is scheduled for April 25. The rate-setters at this point look set to stick with the 50% benchmark.

Following the local elections, with Turkey’s policy rate having ascended to what looks like a peak, the course of the USD/TRY will be observed.

When the northward pull on the pair ends, the moment will be seen as signalling the beginning of portfolio inflows and the opening of the window for slowly building up lira papers.

Ahead of May, when official inflation will peak, the beginning of rate cuts (currently expected in 4Q24) will be discussed.