CBRT clawing back credibility

  • The Turkish central bank’s (CBRT’s) decision to hike its policy rates by 200bp today is a response to the recent lira weakness, and should help to restore the Bank’s battered credibility. The move gives the CBRT more room to tighten monetary conditions through its interest rate ‘corridor’ and we expect that the average cost of central bank liquidity provision will climb to around 12% by year-end (from 10.7% now).
  • Today’s decision was a major surprise. Nearly all of the analysts polled by Bloomberg prior to the meeting, including ourselves, predicted that the benchmark one-week repo rate would be left on hold at 8.25%. Only three of the 31 analysts expected an interest rate hike, albeit smaller than the one actually delivered.
  • The central bank pinned its decision on concerns over inflation, which stood at 11.8% y/y in August – more than double the CBRT’s 5% target. In its July Inflation Report, the central bank raised its inflation forecast. And the statement accompanying today’s decision said that a rise in policy rates was warranted “in order to contain inflation expectations and risks to the inflation outlook”.
  • But any shift in monetary policy always hinged on swings in the lira. The currency has dropped by 10% against the dollar since a de facto peg was abandoned in mid-July (see Chart 1), against the backdrop of large external vulnerabilities and a ratcheting up of tensions with the EU. The central bank had already responded by tightening monetary conditions via the use of its interest rate “corridor”, pushing the average cost of funding up by more than 325bp, to 10.65% as of yesterday. (See Chart 2.)
  • We think that there are two key takeaways from today’s decision. The first is that the CBRT appears keen to claw back some of its damaged credibility. Investors have never looked favourably upon the CBRT’s use of the rate corridor to adjust monetary conditions as it demonstrated the political influence on central bank decisions. Hiking policy rates is a clear step in the right direction and suggests that the CBRT may be taking the fight against inflation more seriously. The CBRT has also acted more quickly than previously to raise policy rates. The lira initially rallied by as much as 1.8% against the dollar on the back of the decision.
  • Second, it’s not clear if raising policy rates will result in an immediate tightening of monetary conditions. After all, the benchmark one-week repo rate, now at 10.25%, is still below the average cost of funding. That said, there is now more scope for the central bank to tighten monetary conditions through the back door, with the late liquidity window – which marks the top of the corridor – now standing at 13.25%.
  • Turkey’s monetary policy framework makes it difficult to predict exactly what will happen to monetary conditions going forward. Developments will almost certainly continue to hinge on moves in the lira which, as we spelt out in an Update yesterday, is likely to fall further. Real interest rates may be one useful guide. Over the past decade, these have averaged around 0%. On this basis, and after factoring in our inflation forecast, the average cost of funding is likely to rise to around 12% over the coming months.
  • The real test, of course, is whether the CBRT backs up today’s decision with further steps to improve its policymaking credibility. Additional tightening at the next few meetings, with a pledge to stick to a single policy rate and a commitment to keep real interest rates positive for a prolonged period, would be ideal. Past experience suggests that we shouldn’t hold our breath.

Chart 1: Turkish Lira (vs. $, Inverted)

Chart 2: CBRT Policy Rates & Avg. Cost of Funding (%)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, CBRT, Capital Economics


Jason Tuvey, Senior Emerging Markets Economist, jason.tuvey@capitaleconomics.com

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