Basci-Erdogan Talks Buy Lira Brief Respite as Fed Concern BuildsBenjamin Harvey and Constantine Courcoulas
The buffer Turkey’s central bank is giving to lira assets may be short-lived as prospects for higher U.S. interest rates overtake a lull in political pressure to cut borrowing costs.
The currency strengthened for a second day and bonds gained after Governor Erdem Basci kept the key interest rate on hold for the first time in three months on Tuesday. The decision came after Basci met with President Recep Tayyip Erdogan last week, spurring optimism politicians will tone down calls for lower borrowing costs and helping slow the lira’s worst start to a year since the currency was devalued in 2001.
While keeping rates unchanged helped restore the central bank’s credibility, it may not have bought Basci much time, according to Piotr Matys of Rabobank. Turkish assets, which Morgan Stanley considers among the most vulnerable to changes in U.S. rates, may come under pressure if the Federal Reserve indicates it’s moving more quickly toward higher borrowing costs after its meeting on Wednesday.
“The Fed after all is on the path that inevitably leads to a hike,” Matys said by e-mail from London on Tuesday. “If the Fed is not as hawkish as anticipated, then the central bank will be looking for the opportunity to ease monetary policy further.”
The lira fell 0.4 percent to 2.6234 per dollar at 2:39 p.m. in Istanbul, after a two-day advance trimmed its depreciation in 2015 to 11 percent. The yield on two-year notes were unchanged at 8.76 percent, after falling for two days from this year’s peak.
Basci kept his main one-week repurchase rate at 7.50 percent and also left the top rate in his so-called interest-rates corridor unchanged at 10.75 percent. The governor has so far trimmed 250 basis points from benchmark borrowing costs since raising them by 550 basis points at an emergency meeting in January 2014.
That hasn’t been enough for some politicians including Erdogan, who say lower rates are needed to boost growth and investment. Economic expansion probably slowed to less than 3 percent in 2014, Deputy Prime Minister Ali Babacan said on March 13. Bank of America Merrill Lynch said the economy won’t do much better this year, cutting its forecast to 3.2 percent after data showed industrial production unexpectedly contracted in January.
Morgan Stanley, which labeled Turkey in 2013 as one of the so-called “Fragile Five” nations most vulnerable to a tightening of U.S. monetary policy, said in a report this week that while some of the countries at risk have adjusted, Turkey, Brazil, Russia and South Africa haven’t.
Turkey could reduce that susceptibility in the short-term by raising interest rates, since improving fundamentals including its external funding dependence would take time, Morgan Stanley said. Instead, rates are probably heading lower this year, according to Tatha Ghose at Commerzbank AG.
The central bank’s rate decision yesterday was “a measure to stabilize the lira by demonstrating that the central bank can still make independent decisions,” Ghose said by e-mail on Tuesday. “Nevertheless, the oil price is fully supportive again and the current-account deficit has been narrowing rapidly, so we still expect rates to be 100 basis points lower by the end of the third quarter.”
Turkey imports more than 90 percent of its oil, and each $10 decline in the cost of a barrel of crude improves the nation’s current-account deficit by about 0.6 percentage-point of GDP, Finance Minister Mehmet Simsek said in October last year. Brent crude has fallen about $9 a barrel this month.
Political pressure on the central bank exacerbated the lira’s decline against the dollar along with other emerging-market currencies as the U.S. moves closer to raising rates, according to Henrik Gullberg, a currency strategist at Deutsche Bank AG in London.
The tone of communications has softened since Erdogan met with Basci March 11, after which he said the two are on good terms. The central bank is independent in the tools it uses to carry out monetary policy and has had a good track record since 2002, the prime minister’s office said March 10.
“It seems politicians now realize the risks of putting the Central Bank of Turkey under pressure,” Gullberg said by e-mail on Tuesday. “But for the lira to be out of the woods, the market needs a period of stable and credible monetary policy, as well as signs growth is picking up. Until then, the lira will remain vulnerable.”