Turkey’s central bank Governor Erdem Basci said he won’t increase interest rates to fight a deepening slump in the lira, and instead promised to use “surprise” tools to reverse the trend.
The bank has $40 billion in reserves it can use to defend the lira, which fell to a record low against the dollar today, Basci said in a televised interview with state-run AAFinans. He said the bank won’t change its overnight lending rates, the top end of its interest-rate corridor, and will later announce “new tools” to support the currency.
Basci increased the lending rate this month and last, and has spent $8.7 billion buying liras since June 11. The Turkish currency has fallen 12 percent against the dollar this year, the second-most among currencies in Europe, Africa and the Middle East after South Africa’s rand, according to data compiled by Bloomberg. The slide in emerging-market currencies began in May when the U.S. Federal Reserve signaled it may scale back its monetary stimulus.
“If we stay firm on the interest rates, lira depreciation can reverse in a few days,” Basci said. “We’ll defend the lira like lions. That will be through the foreign-exchange weapon. We will not use interest rates.”
The lira weakened 1.2 percent to 2.0210 per dollar at 1:20 p.m. in Istanbul, after falling as much as 1.9 percent on Basci’s comments. Yields on two-year benchmark lira bonds fell 35 basis points, or 0.35 percentage point, to 9.81 percent.
“Eliminating the rate hike option completely and relying mainly on foreign-exchange sales is a fragile strategy against a backdrop of upward adjusting global interest rates,” Gokce Celik, an economist at Finansbank AS in Istanbul, said in e-mailed comments.
Basci said that “panic selling” spurred by the prospect of tighter policy in the U.S. is causing “excessive” lira depreciation which is expected to be temporary. He forecast that the currency may strengthen to 1.92 per dollar by year-end.
Turkey is better placed than many other emerging markets to weather the selloff because of the central bank’s “rich set of monetary tools,” Basci said, though he also said that using a range of mechanisms can lead to “predictability problems.” He said the “surprise” new measures will enable the bank to “break the back of foreign exchanges without spending much of our reserves.” He didn’t give details.
“I expect the bank to impose restrictions on the amount of foreign exchange that can be held instead of lira,” Ipek Ozkardeskaya, a currency strategist at Swissquote Bank SA in Geneva, said by e-mail after Basci’s comments today, describing that as “the only possible maneuver.”
Basci has been using a tool called the reserves option mechanism to adjust the cost to banks of holding required reserves in gold or foreign exchange instead of liras. It’s designed to control liquidity and diminish the need for direct currency interventions by the central bank, though Basci has still resorted to lira purchases since June 11.
Basci said there will be no further increases this year to the overnight lending rate, which he raised by a half-point to 7.75 percent on Aug. 20. He said the rate of overnight lending to big banks, which is 1 percentage point lower, will also stay the same until inflation comes in line with the bank’s 6.2 percent year-end forecast.
Inflation accelerated to 8.9 percent last month. It will start to slow in August with a “normalization in food prices” and will near the bank’s medium-term target of 5 percent by February, Basci said.