Orphaned Inflation Hurting Debt as Erdogan Girds for VoteSelcan Hacaoglu
Turkish inflation isn’t going the way central bank Governor Erdem Basci said it would, and investors in lira bonds are paying the price.
Consumer prices jumped 9.32 percent in July from a year earlier, more than any economist forecast in a Bloomberg survey, sending yields on two-year notes up 58 basis points in the biggest increase among major emerging markets yesterday. With inflation moving away from Basci’s 7.6 percent 2014 forecast and his 5 percent target for next year, analysts are questioning whether the central bank can curb prices amid government pressure to keep reducing borrowing costs.
While Basci has lowered the benchmark repurchase rate by 1.75 percentage points since April, Prime Minister Recep Tayyip Erdogan, who faces voters on Aug. 10 in his campaign for president, has called for deeper cuts to spur the economy. Inflation, which was more than 20 percent when Erdogan came to power in 2003, has stayed above the central bank’s target for six of the past eight years.
“The inflation target has been orphaned, when Turkey of all countries should realize the fallacy of trading inflation for short-term growth,” Murat Gulkan, managing director at Istanbul-based Unlu Portfolio Management, said by telephone yesterday. “The destructive effects of inflation are far reaching. Current rates offer no attractiveness whatsoever.”
The 9.32 percent yield on two-year notes yesterday compares with an average inflation rate of 9.38 percent in the four months to July. Goldman Sachs Group Inc. raised its year-end estimate for consumer-price growth to 9.2 percent from 8.9 percent after yesterday’s data, according to a report by economists Ahmet Akarli and Kasper Lund-Jensen.
The worsening numbers may not deter Basci from further reductions even though “the case for monetary easing remains weak,” they said. Basci will probably cut another 50 basis points from the main one-week repo rate in the short-term, while in the longer term he’ll eventually be forced to raise the policy rate to 12 percent from the current 8.25 percent, according to the report.
“This will be a key test of the Turkish central bank’s credibility,” Tim Ash, an emerging-market economist at Standard Bank Group Ltd. in London, said by e-mail yesterday. “To cut rates now with this rise in headline inflation will risk sending a very negative signal to the market that the central bank does not care much about inflation -- as long as it is below 10 percent.”
Morgan Stanley increased its year-end projection for price growth yesterday to 9.1 percent from 8.5 percent, while also predicting interest rates will fall further. Basci’s 5 percent target has “lost its significance for all intents and purposes,” Tevfik Aksoy, the bank’s London-based chief economist for Europe, Middle East and Africa, said in an e-mailed report.
The central bank may revise its inflation target unless it’s achieved by the end of next year, Basci said July 24. The core inflation rate, which strips out volatile items including food, gold and energy, climbed to 9.75 percent in July, near the seven-year high of 9.77 percent recorded in May.
The lira strengthened 0.25 percent to 2.1258 per dollar at 12:36 p.m. in Istanbul today.
The two-year break-even rate, a measure of inflation expectations, rose 57 basis points to a two-month high of 7.40 percent yesterday. Yields on two-year notes fell 21 basis points to 9.11 percent today.
Investors should “take profit” on their positions in long-dated Turkish bonds given central bank “dovishness,” Phoenix Kalen, Societe Generale SA’s emerging-markets strategist, said yesterday.
“Barring an unforeseen run on the lira later this month, we believe that the central bank will continue to reduce policy rates,” Kalen said in a report from London. Despite “troubling inflationary developments,” policy makers will be “disinclined to pause in their current easing cycle,” she said.