Turkey Expected to Raise Rates After ‘Backdoor’ Moves to Bolster Lira

  • Economists expect central bank to raise all three main rates
  • Widening rates corridor seen as halt to simplification process

Turkey’s central bank is likely to step up efforts to prop up the lira with higher interest rates, seeking to build momentum after a series of extraordinary measures to tighten liquidity.

Economists expect the bank to raise its three main rates on Tuesday, days after it used what Deputy Prime Minister Mehmet Simsek called a “backdoor” channel to raise borrowing costs to stem the lira’s plunge. Commercial lenders were forced to borrow using a more expensive and little-used interest rate, the late-liquidity window, and the regulator is using swaps to reduce volatility.

The extraordinary measures came as the usual demands from President Recep Tayyip Erdogan’s officials for lower rates to spur growth softened in recent weeks, with the lira trading at record lows against the dollar and Turkey’s economy hurt by terrorist attacks and July’s coup attempt. Global demand for riskier assets has also weakened since Donald Trump’s U.S. election victory.

“The Turkish central bank has responded to currency weakness by tightening liquidity conditions significantly in the last nine days,” Yarkin Cebeci, a London-based economist at JPMorgan, said in a report. “This move, in our view, strongly signals a formal rate hike” at Tuesday’s monetary policy committee meeting, he said.

The regulator will raise the one-week repo rate by 50 basis points to 8.5 percent and the overnight lending rate by 75 basis points to 9.25 percent, according to the median estimate in Bloomberg surveys. They show a 25 basis-point boost to the overnight borrowing rate to 7.5 percent.

Economists also said that would effectively halt the bank’s plan to simplify monetary policy by reducing the gap between the overnight lending and borrowing rates, and using the one-week repo rate as the main funding tool.

The gap narrowed to one percentage point in September -- the narrowest since it began using a three-gauge policy in 2010 -- and while it widened again when the central bank raised rates for the first time in almost three years in November, Governor Murat Cetinkaya said only two weeks later that the bank’s aim hadn’t changed.

‘Shelving’

Widening the corridor to 1.75 percent would represent the “shelving of simplification,” said Gokce Celik, chief economist at QNB Finansbank in Istanbul. The bank may be hoping that reverting to a wider rates corridor, and the potential volatility that brings to the cost of funding, will allow it to stabilize the lira with a rate increase smaller than the 300 to 400 basis points that some investors had called for, she said.

Its recent measures suggest the central bank “has reversed its strategy of policy simplification and has returned to using the flexibility provided by its interest rate corridor,” said Cebeci at JPMorgan.

Government calls for cheaper credit have come despite the central bank missing its inflation target for six consecutive years. Consumer prices rose an annual 8.5 percent in 2016, well above the bank’s 5 percent target.

“Clearly the economy is weak,” Simsek said last week in Davos, Switzerland, describing “so so” growth in the fourth quarter following a contraction in the third. Though that poses a “dilemma” for the regulator, “it’s still a decision the central bank needs to be making on the basis of price stability as well as other macro financial stability considerations,” he said.

Resistance

Some officials are still voicing reservations about higher rates. Bulent Gedikli, an adviser to Erdogan, said recent steps to tighten liquidity had stabilized the lira and will allow policy makers to refrain from increasing borrowing costs.

The lira surged against the dollar on Tuesday and Friday last week as investors absorbed the new measures. But it was still down 1.2 percent on the week, extending its 2017 losses to about 7 percent following its 17 percent plunge last year. It traded 0.4 percent weaker to 3.7710 against the dollar as of 9:54 a.m. in Istanbul.

Most economists say that makes a rate increase on Tuesday inevitable, though they differ on the expected scale.

Phoenix Kalen, a London-based emerging-markets strategist at Societe Generale, sees a 100-basis-point rise in the overnight lending gauge to “send a credible signal to the market,” according to e-mailed comments last week. That might “prevent a currency run, although it may not be sufficient to catalyze a sustained rally,” she said.

Ercan Erguzel, an analyst at Morgan Stanley in Istanbul, said January’s measures could allow the bank to avoid large rate increases. The bank might be able to drive up offshore swap rates through the swap auctions, making it more costly to bet against the currency, he said in a Jan. 19 note, adding that “unorthodoxy is good.”

“We expect the central bank to make measured hikes of 25 basis points” to the one-week repo and overnight lending rates, Erguzel said. “It may consider a bigger hike, such as 100 basis points, in the late liquidity window” to better ward against further lira volatility, he said.

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