Morgan Stanley Sees Basci Viewing Rate Increase as Wasted

Turkey’s central bank kept interest rates unchanged, opting instead to raise money market borrowing costs in what Morgan Stanley called a “stealth tightening.”

The central bank in Ankara maintained the overnight lending rate at 7.75 percent, in line with the median forecast in a Bloomberg survey of 14 economists. Lenders including Morgan Stanley and Goldman Sachs Group Inc. predicted at least a 50 basis point increase. The one-week repurchase and overnight borrowing rates were also held, as predicted in surveys. The lira tumbled to a record low.

Morgan Stanley economist Tevfik Aksoy said before the decision that the central bank may have considered increasing interest rates a “wasted” effort given risks that a graft crisis embroiling the government will escalate. While raising interbank money-market rates could help stabilize the lira, questions remain as to how the operation will work, he said in a report e-mailed after the outcome. The yield on two-year notes has climbed 127 basis points since the crisis erupted on Dec. 17, the most among 18 emerging markets.

“We find it difficult to relax on this stealth tightening,” Aksoy, Morgan Stanley’s chief economist in London for central and eastern Europe, the Middle East and Africa, wrote in the research. “The outcome was clearly a disappointment, given the widening credibility gap, rising inflation, the ongoing weakening in the currency and rising skepticism among investors regarding the effectiveness of policy implementation.”

Inflation Outlook

Basci said Dec. 24 that he’ll keep interest rates unchanged unless he sees a deterioration in inflation. Price growth accelerated to 7.4 percent in December from 7.32 percent a month earlier, the state statistics office said on Jan. 3.

“Inflation is likely to hover above the 5 percent target for some time due to recent tax adjustments and lagged effects of exchange rate developments,” the central bank said in a statement today. “The committee stated that the liquidity stance should be tightened to align inflation outlook with the medium term targets. To this end, interbank money market interest rates will materialize at 9 percent during additional monetary tightening days, instead of 7.75 percent”

Inflation expectations for the next 24 months climbed to 6.5 percent, the highest level since December 2011, according to central bank survey of economists released Jan. 17. That’s up from 5.8 percent in May, the data show.

While Basci is “more inclined to keep rates on hold,” given the bank’s statements that policy is sufficiently tight he will go for a “controlled” increase of 50 basis points to prevent a worsening of the inflation outlook, Goldman Sachs analyst Ahmet Akarli in London said last week.

Overshoot Risk

“It will not be easy for the monetary policy committee to deliver a rate hike,” Akarli said in an e-mailed note on Jan. 17. “However, a failure to respond to intensifying depreciation pressure on the lira can run the risk of an even larger and more persistent inflation overshoot.”

The lira slid as much as 1.3 percent to 2.2691 per dollar after the decision and traded 0.9 percent weaker at 2.2610 as of 5:30 p.m. in Istanbul. The currency has lost about 18 percent since the Federal Reserve said May 22 it could start to scale back stimulus.

Technical indicators show the shorter-term bullish dollar-lira trend may begin to weaken, raising the prospect of a near-term lira appreciation or pause in its decline. The 14-day ADX study, a measure of strength of the prevailing trend, is now at 44. Readings above 40 indicate that the trend in place is at an extreme and may not be sustained. The daily moving average convergence-divergence, or MACD, which provides buy and sell signals, indicates that the short-term momentum behind the lira’s depreciation is diminishing.

Slowing Growth

Basci vowed in August to keep rates on hold last year as the economy recovered from its worst growth since the recession in 2009. The expansion will probably slow to 3.5 percent this year, from 3.85 percent in 2013, according to Bloomberg surveys of economists.

Growth remains a priority for Basci who will maintain rates so as not to dim Turkey’s outlook further, according to Nihan Ziya-Erdem, an economist at Turkiye Garanti Bankasi AS in Istanbul.

“The central bank clearly stated earlier that it won’t interfere in the foreign-exchange rates using interest rates,” Ziya-Erdem said. “The central bank will not hike rates if economic growth is expected to slow down.”

The yield on Turkey’s two-year lira notes rose three basis points, or 0.03 percentage points, to a two-week high of 10.19 percent today. Credit-default swaps, contracts insuring the nation’s debt against non-payment, fell four basis points to 244.

Political Turmoil

Political “uncertainty” will probably weigh on private investment and consumer sentiment, which will eventually lead to a loss of momentum in economic growth, according to Morgan Stanley.

Foreign-investor holdings of Turkish debt dropped to $50.4 billion in the week ended Jan. 10, from $71.8 billion in the period ended May 10, according to central bank data.

“Clearly, from a standard or conventional point of view, there has been no change in the relevant interest rates,” Morgan Stanley’s Aksoy said in the report.

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