In Basci We Trust as Market Faithful Invert Curve: Turkey Credit

The Turkish government wants the central bank to prioritize growth over tackling above-target inflation by cutting interest rates. The bond market says that Governor Erdem Basci won’t cave into the pressure.

Ten-year bonds rallied on May 2, pushing the yield below two-year debt for the first time in almost a month, on speculation policy makers will keep borrowing costs elevated. The so-called curve inverted further on May 5, when a report showed annual consumer prices accelerated a more-than-forecast 9.4 percent last month, sending two-year note yields up by the most since January.

“Inversion signals that the market expects tightening to continue,” Ugur Kucuk, a fixed-income strategist at Is Investment Securities in Istanbul, said by phone yesterday. “That would help the central bank keep a lid on domestic demand and boost the lira’s attractiveness, thus reining in inflation on two fronts.”

Inflation’s surge to a two-year high will be shortlived and doesn’t weaken the case for cutting rates, Economy Minister Nihat Zeybekci said the day of the report. He was echoing comments made by Prime Minister Recep Tayyip Erdogan since the benchmark was more than doubled to 10 percent in January to arrest a slump in the lira. The central bank might start reducing borrowing costs if the risk premium on Turkish assets falls and inflation expectations decline, Basci said on April 30.

Erdogan Emboldened

“The bank should cut the same way it raised at an emergency meeting,” Erdogan said on April 4 after his Justice and Development Party’s victory at March 30 local elections.

Erdogan’s AKP got almost 46 percent of the votes, surpassing the total cast for two main opposition parties. Since the poll, the yield on two-year government notes declined 168 basis points, the most among 21 emerging markets tracked by Bloomberg.

The central bank is “responsible only for price stability,” Basci said at a conference yesterday, according to the state-run Anadolu Agency. Policy makers target 5 percent inflation.

Their commitment to reining in price growth “instills confidence in investors,” as observed in capital inflows, according to Nilay Akcay Yores, treasury manager at Turkish Bank AS in Istanbul.

Bond Inflows

In the four weeks to April 25, net foreign purchases of Turkish debt were $696 million, compared with outflows of $3.6 billion in the first quarter, according to data compiled by Bloomberg.

“Inflation could remain elevated in May and June, and then there’s the Aug. 10 presidential elections,” Yores said, predicting interest rates will be cut no earlier than September.

The cost of insuring Turkish dollar-denominated debt against default using a five-year credit-default swap fell to 183 basis points yesterday from 232 before the election, according to data compiled by Bloomberg.

The lira has rallied 5.6 percent against the dollar since March 28, the best performance among 24 developing-nation currencies tracked by Bloomberg. It strengthened 0.3 percent to 2.0751 per dollar at 1:32 p.m. in Istanbul, an 11th day of gains, the longest streak in four years.

“The bank is keeping short-term funding conditions tight due to the inflation outlook,” Bora Tamer Yilmaz, an economist at Ziraat Investment in Istanbul, said by e-mail yesterday. “That’s lira-positive.”

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