Lira Rises on Relief Over New Governor's First Interest Rate Cut

  • Overnight-lending rate cut 50 basis points to 10 percent
  • The currency advances to strongest level in two weeks

Currency and bond traders welcomed Turkey’s new central bank Governor Murat Cetinkaya’s decision to cut interest rates in line with forecasts, a sign he wasn’t succumbing to government pressure for steeper reductions.

The currency advanced to the highest level in more than two weeks, rising 0.7 percent against the dollar as of 6:22 p.m. in Istanbul to 2.8123. Cetinkaya lowered the overnight lending rate by 50 basis points to 10 percent, in line with the median estimate of 21 analysts surveyed by Bloomberg. Government bonds rallied, sending yields to the lowest level since May.

The decision eased concern policy makers would give in under new leadership to calls by President Recep Tayyip Erdogan and some government officials to radically cut borrowing costs to lift the $720 billion economy. The second cut to borrowing costs in as many months comes amid a slowdown in inflation and renewed appetite for riskier assets.

“The lira is still performing relatively well against the U.S. dollar and sentiment towards emerging markets continue to improve gradually,” so the decision is justified, said Piotr Matys, an emerging-market strategist at Rabobank in London. “It’s also a continuation of the process that started before Murat Cetinkaya became the governor so his credibility remains intact.”

More Cuts

The central bank kept the one-week repurchase rate and the overnight-borrowing rate unchanged at 7.5 percent and 7.25 percent, respectively.

The bank has room to cut the overnight-lending rate by another 50 basis points over the next 12 months, unless a deterioration in global financial markets hurts investor appetite, said Sakir Turan, an Istanbul-based economist at Odea Bank AS who accurately predicted the decision on Wednesday.

Cetinkaya’s predecessor, Erdem Basci, pledged to abandon the bank’s three-tiered policy framework in favor of a single benchmark rate. Investors will be looking for clues for how the new governor will follow through on this plan, said Ozlem Derici, an economist at Istanbul-based broker Deniz Invest.

Lira Yield

Even after the interest rate cut, the lira offers the best potential returns in emerging markets relative to the currency’s expected price swings. That boosts its allure for carry traders, who borrow where costs are low and invest in higher-yielding assets.

The recent decline in inflation, which slowed for a second month in March, is mainly due to a drop in unprocessed food prices, and while it’s expected to continue in the near term, the improvement in core inflation “remains limited, necessitating the maintenance of a tight liquidity stance,” the central bank said in a statement on its website on Wednesday.

Funding Costs

Policy makers adjust borrowing costs for banks by varying the amount of liquidity they provide through daily one-week repo auctions. The weighted average cost of funding has declined almost 50 basis points from this year’s high in February to 8.65 percent on Tuesday, according to central bank data compiled by Bloomberg.

The central bank’s reference to the limited improvement in core inflation “eliminates expectations over a too dovish central bank and would be positive for the currency,” said Istanbul-based Erkin Isik, a strategist at Turk Ekonomi Bankasi AS.

The yield on the government’s 10-year local currency debt retreated 17 basis points to 9.13 percent.

Banks Plunge

The Borsa Istanbul Banks Sector Index fell 1.1 percent, reversing an earlier gain of as much as 1.3 percent and helping to drag the benchmark gauge down 0.8 percent on speculation the rally was overdone.

The decline in interest rates was “broadly priced in ahead of the decision,” said Gulsen Ayaz, a director of institutional equity sales at Deniz Invest in Istanbul. Although the market reacted positively initially, the “profit taking incentive after the fact dominated towards the close,” she said.

Cetinkaya’s first public address at the quarterly inflation report on April 26 will be crucial for investors to evaluate the “further upside potential for lira assets,” she said.

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