Lira Sliding to Rescue Shifts Basci’s Rates Focus: Turkey Credit

The lira’s drop over the past month is fueling speculation the central bank will revert to focusing on inflation instead of the currency, reducing chances of an interest-rate cut that would support bonds.

The lira weakened 2 percent since the beginning of February, bringing an index monitored by the central bank below its threshold for action to stem appreciation. Turkey’s bond rally, lagging behind Slovenia, Romania, Mexico and Russia this year after beating 20 major emerging markets in 2012, is stalling as investors bet the bank is nearing the end of rate cuts that began last May.

That may limit room for yields to fall further as the central bank looks to end a three-year streak of missing inflation targets. Governor Erdem Basci said that policy makers were monitoring the real effective exchange rate index, or REER, in November, noting a reading above 120 would suggest the currency was overvalued and could prompt a response. The index, which is reported by the central bank monthly, was at 119.69 in February, the bank said yesterday.

“Loose monetary policy and hectic corridor adjustments are over,” Cenk Sidar, managing director of Washington-based Sidar Global Advisors, said in an e-mail March 4, referring to the bank’s interest-rate corridor. “The central bank has done quite a bit for sustaining growth and fighting currency appreciation.”

Currency Outlook

Yields on benchmark two-year debt fell two basis points, or

0.02 percentage point, to 5.74 percent at 5:51 p.m. in Istanbul, a second day of declines after rising eight basis points the previous two days. The lira weakened 0.2 percent to 1.7949 per dollar, bringing its loss this year to 0.6 percent.

Persistent lira depreciation could create “stickiness” in inflation and prompt the central bank to “deliver an inflation-focused policy response,” Vakifbank economists including Cem Eroglu and Umit Unsal said in a report e-mailed on March 4. “The bank’s monetary policy committee might keep the interest-rate corridor unchanged when it meets on March 26, shifting toward a wait-and-see policy.”

Garanti Securities, the investment unit of Turkey’s biggest bank, said it was maintaining its forecast for a 25 basis-point cut to the upper and lower limits of the corridor after the REER gauge neared the bank’s threshold, according to an e-mail from economist Gizem Oztok Altinsac yesterday. “We’ll revisit our forecast according to the outlook for the lira,” as the meeting approaches, she said.

Funding Cost

Basci uses the overnight lending and borrowing rates, together defining the corridor, in addition to the benchmark rate of 5.5 percent, to manage liquidity in the $800 billion economy. The average cost of funding to banks has hovered around

5.5 percent since December, after being cut from as high as 10.8 percent last May, according to data compiled by Bloomberg. The rate was 5.53 percent yesterday.

Slower-than-expected inflation in February failed to trigger a decline in Turkish bond yields amid a pick-up in core inflation. Annual consumer-price growth slowed to 7.03 percent in February from the previous month, while core inflation rose to 5.82 percent from 5.72 percent, according to the statistics office in Ankara March 4.

“Inflation is still benign, but core continues to gather momentum,” Goldman Sachs Group Inc. analysts Mark Tan and Hui Ying Chan said in an e-mail yesterday. “In the second half, inflation will prove to be consistently more sticky at around 7 percent.”

Forward Rates

The lira will weaken to about 1.87 per dollar by year-end, according to implied forward rates calculated by Bloomberg. Inflation will probably end the year at 6.8 percent, according to the average of 24 economist estimates compiled by Bloomberg.

The extra yield investors demand to hold Turkey’s dollar debt over U.S. Treasuries fell seven basis points to 196 today, according to JPMorgan Chase & Co.’s EMBI Global Diversified Index. Turkey’s spread is 85 basis points below the average for emerging markets.

Five-year credit-default swaps on Turkey fell one basis point to 134 basis points. That compares with 145 for Russia and 170 for South Africa, both of which are rated higher. Falling prices show improving perceptions of creditworthiness and rising prices the reverse. The contracts pay the buyer face value in exchange for the underlying securities or cash equivalent if a borrower fails to adhere to its debt agreements.

The benchmark yield is determined largely by the average cost of funding from the central bank, according to Hakan Aklar, an economist at Ak Investment in Istanbul.

“If the yield is to go further south, inflation must fall considerably,” he said.

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