Turkish Bonds Rise as Bank’s Currency Measure Crosses Threshold

Turkey’s bonds rose after an index that the central bank uses to measure the lira’s strength signaled the currency is overvalued, fueling speculation of an interest rate cut this month. The lira erased gains.

Yields on two-year benchmark notes extended this year’s drop to 40 basis points, the steepest slide among 18 major emerging markets, after the Real Effective Exchange Rate Index surpassed a threshold today that central bank Governor Erdem Basci said could result in policy action.

“If the lira retains its current levels, the REER may stay above 120 in February,” Ali Cakiroglu, a strategist at HSBC Asset Management in Istanbul, wrote in an e-mailed note. “The possibility of a new cut in overnight borrowing rates is intact.”

Yields on two-year notes fell six basis points, or 0.06 percentage point, at 5.78 percent, the lowest level on a closing basis since Dec. 17. The lira wiped out an earlier advance of as much as 0.2 percent against the dollar and traded little changed at 1.7615 by 5:36 p.m. in Istanbul.

The REER, which monitors the lira against Turkey’s trade partners, rose to 120.16 in January from 118.08 in December, according to central bank data. A reading of 120 or above signals excessive currency strength. Turkey’s rate-setting meeting is scheduled for Feb. 19.

A “measured rate cut to the interest rate corridor or policy rate is possible if the real effective exchange rate appreciates excessively,” Basci said Jan. 29. The lira gained 1.3 percent this year against the dollar, extending last year’s 6 percent appreciation, and 1.2 percent against the euro.

Basci has used an interest-rate corridor since October 2011 to adjust borrowing rates and manage capital flows.

“If the REER exceeds 130, the central bank will consider more radical interest rate cuts at the lower band and other measures,” Ercan Erguzel, an economist at Denizbank AS in Istanbul, said in e-mailed comments.

Basci cut the overnight lending and borrowing rates by 25 basis points on Jan. 22 and raised reserve requirements for lenders to curb credit growth that had started to grow “faster than envisaged, amid accelerating capital inflows,” policy makers said in a statement.

One-year interest-rate swaps, which indicate investor expectations of borrowing costs, fell three basis points to 6.54 percent today.

“Based on the current exchange rate and credit outlook, we are expecting 25 basis points reduction in the lower band of the corridor and one percentage point increase in lira reserve requirements,” Gizem Oztok Altinsac, an economist at Garanti Investment in Istanbul, said in an e-mailed note.

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