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Basci to Maintain Rates While Boosting Dollar Sales for Lira

Turkish central bank Governor Erdem Basci says he’ll keep interest rates on hold unless he sees a worsening in inflation, while using dollar sales and reserve options to defend the lira, which he says is oversold.

The central bank’s overnight lending rate of 7.75 percent is the new reference interest rate and sufficient to fight inflation, Basci said in Ankara at a speech on monetary policy for the year ahead. The bank is now using three rates to set monetary policy, while keeping its former benchmark, the one-week repo rate, unchanged at 4.5 percent since May. Basci raised the overnight lending rate gradually to its current level from 6.5 percent over the same period.

A combination of liquidity tools and measures to limit growth in consumer loans will be employed before the bank makes any decision on interest rates, Basci said. The bank “might make adjustments” in interest rates should inflation expectations worsen, he said. Annual consumer-price gains were 7.32 percent last month, above the bank’s target of 5 percent for a third year.

“We understand from the central bank governor’s remarks that he’ll continue tight liquidity policies and will even increase liquidity needs from the start of 2014,” Garanti Yatirim, the investment unit of Turkiye Garanti Bankasi AS, said in an e-mailed report after Basci’s speech. “We expect to see a general increase in all market interest rates.”

Bond Yields

The yield on Turkey’s two-year benchmark notes fell 4 basis points, or 0.04 percentage point, to 9.72 percent at 11:57 a.m. in Istanbul today. It reached a record low of 4.79 percent on May 17. That was before U.S. Federal Reserve Chairman Ben S. Bernanke said May 22 he was considering reducing record U.S. stimulus. U.S. policy makers last week said they’d begin cutting their $85 billion in monthly bond purchases by $10 billion next month.

Turkey will tighten liquidity in its banking system by reserve-options mechanism coefficients and by selling at least $450 million a day in foreign-exchange auctions through year-end, and at least $100 million a day in January, Basci said today. The reserve options mechanism, or ROM, allows lenders to hold part of their required lira reserves in foreign exchange or gold. An increase in the ROM coefficients, or ROCs, can increase the banking system’s funding gap as commercial banks store more liras as reserves at the central bank.

Buying Time

The bank increased all ROCs for tranches of commercial banks’ reserves corresponding to 40 percent to 60 percent, according to a statement posted on its website. It also “simplified” the calculation of required reserves, which it expects to inject an additional $1 billion into the market.

“The central bank is trying to buy time with previously tested instruments. It should have seen the impact of these liquidity tools so far,” Ibrahim Aksoy, chief economist at Gedik Investment in Istanbul, said by phone today. “The bank does not prefer to increase interest rates against currency weakness.”

Turkish banks’ share in borrowing through the central bank’s one-week repurchase rate at 4.5 percent will be linked to the amount of their required reserves held at the central bank, Basci said today. He didn’t provide further details on how the link would be implemented.

Basci has sold about $15 billion in foreign-currency auctions since June, a period during which the lira weakened by about 9 percent, the most among major emerging markets in eastern Europe, the Middle East and Africa. The minimum amounts announced today mean he’ll sell another $3 billion by year-end and at least $3 billion in January.

The lira strengthened 0.8 percent to 2.0803 per dollar at 1:12 p.m. The currency hit a record low of 2.0992 per dollar earlier today.

“The bank announced high foreign-exchange auctions for the remainder of the year,” Aksoy said. “ This may be positive for the lira in the short term. But the bank can’t stop lira depreciation by using the same tools.”

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