Turkey’s Roadmap Leads to Greater Risks for Tumbling Lira, Bonds

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Highest Turkish central bank funding costs this year have failed to stem the lira's plunge to record lows as benchmark interest rates are kept on hold for a sixth month

A complicated statement to simplify monetary policy.

That’s how investors, at least, took the statement that followed yesterday’s announcement by the Turkish central bank that it would keep its interest rates on hold, as bonds and the lira tumbled and the cost of protecting against a debt default soared to the highest in more than a year. Investors get a second chance to understand Governor Erdem Basci’s logic and the policy “roadmap” he unveiled at the bank’s regular monthly meeting with economists on Wednesday.

It’s rarely been more urgent. Basci’s set of nine measures to put Turkey on a course to simplify monetary policy from its present jumble of benchmark rates didn’t stop the lira sinking to a record low for a fourth day as bond yields surged the most since February.

“The bank has taken a rather risky course of inaction while looking fairly complacent,” Murat Ucer, a former central bank adviser who’s now an economist for Globalsource Partners Inc. in Istanbul, said by e-mail. “It has also provided no guidance as to what is meant by policy simplification, preferring to issue instead a disappointingly elementary note on liquidity measures.”

The roadmap includes a pledge to narrow the gap between central bank overnight lending and borrowing rates, known as the rates corridor, currently held at 10.75 and 7.25 percent. Adjustments to banks’ borrowing limits and the level at which it remunerates lenders for compulsory reserves held in liras are also among the measures.

Turkey’s central bank told economists in Ankara today that it will publish an additional document with technical details on its “road map,” according to two economists attending who asked not to be identified because the meeting is private.

More Light

“We would like more clarity on the roadmap, and the central bank’s meeting” may shed more light, Ercan Erguzel, an economist at Morgan Stanley in Istanbul, wrote in an e-mailed report. The bank raised its recommended weighting on Turkey to neutral last week.

The central bank held the one-week repurchase rate at 7.50 percent, in line with the median estimate in a Bloomberg survey of 17 economists. The lower and upper ends of the corridor were also left unchanged.

While policy makers kept the repo rate on hold for a sixth month, the weighted-average cost of central bank funding has climbed to 8.74 percent, the highest this year. The bank decided to implement a tighter liquidity policy “as long as deemed necessary,” it said in a statement accompanying its rates decision yesterday.

It’s “promising to see that the central bank will maintain its highly effective interest-rate corridor for a while,” Erguzel wrote, pointing to other ways the bank can tighten policy.

Yields on two-year government debt reached the highest in more than a year at 10.68 percent, while the cost of five-year credit-default swaps climbed to the highest since March 2014. The lira fell as much as 1.3 percent to a record 2.9066 per dollar after the road map was published, before strengthening for the first day in five today to 2.8924 per dollar at 12:01 p.m. in Istanbul.

Its relative strength after inflation, or the real effective exchange rate, was weaker last week than levels that preceded emergency interest-rate increases in January last year, according to Erkin Isik, a strategist at Turk Ekonomi Bankasi AS.

Least Resistance

“Further lira weakness is the path of least resistance,” Inan Demir, the chief economist at Finansbank AS in Istanbul, said in an e-mailed report. “A re-run of January 2014 would not be surprising.”

Weighing on the markets is Turkey’s second election this year and the breakdown of a three-year cease-fire with autonomy-seeking Kurds. The Federal Reserve is scheduled to release the minutes of its last policy meeting Wednesday that may provide clues as to the timing of its first increase in almost a decade.

Yesterday’s rate announcement was a “golden opportunity to stop the panic in the markets,” Selim Cakir, the chief economist at Turk Ekonomi Bankasi AS in Istanbul, said in an e-mailed report. Faced with increasing domestic political uncertainty and capital outflows from emerging economies, markets are unlikely to be patient enough to wait too long for the central bank to make its rate move, he said.

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