Turkey Unexpectedly Raises a Key Rate, Citing Inflation Risk

Updated on
  • Bank keeps one-week repo, overnight funding rates unchanged
  • Bloomberg survey called for no change to late liquidity rate

Turkey’s central bank unexpectedly increased the interest rate used for about 90 percent of recent funding to commercial lenders, a decision that gives it additional flexibility in case of future pressure on the lira as it highlighted continued risks from inflation.

The bank raised the late liquidity window rate by 50 basis points to 12.25 percent, while the median estimate in a Bloomberg survey called for no change. The bank kept its one-week repo, overnight lending and borrowing rates unchanged, in line with the survey.

“Further monetary tightening will be delivered if needed,” the bank said in an emailed statement on Wednesday, adding that it will keep a tight monetary stance until the inflation outlook improves significantly. Currency weakness and food prices are driving up inflation, it said. Price gains accelerated to more than 11 percent last month, compared with the bank’s long-term target of 5 percent.

The third tightening in as many meetings will allow the regulator to protect the currency if needed by changing its funding mix, without having to wait until the next scheduled meeting in June. Policy makers have been forcing lenders to use the previously little-used late liquidity window, which is more expensive than Turkey’s three other key rates, since January -- pushing borrowing costs to the highest level in almost five years to boost the lira.

The rate increase “indicates that policy makers may have greater resolve to tackle the country’s inflation problem than we (and most others) had anticipated,” William Jackson, a senior emerging markets economist at Capital Economics in London, said in an emailed note. “We think headline inflation is very close to peaking and further rate hikes are unlikely. However, today’s move suggests the monetary policy committee may ultimately be slower to reverse recent rate hikes than in the past.”

Lira Weakens

The lira strengthened after the decision, before reverting to a loss. It was trading 0.1 percent lower at 3.5813 per dollar at 4:02 p.m. in Istanbul.

The increase doesn’t automatically mean that lira liquidity will be tightened, according to Can Uz, Istanbul-based chief economist of Yatirim Finansman Securities. Rather, it gives the central bank some room to protect the lira in case inflation accelerates further, he said.

Governor Murat Cetinkaya began using the late liquidity rate in January to reduce lira liquidity after it fell to a record low against the dollar. Since then, the amount of cash it provides through the tool has risen to about 90 percent of the total, meaning that it can choose whether to pass on some or none of the rate increase to lenders by adjusting the funding composition.

“I don’t think the central bank will change its short-term liquidity policy, or increase the average cost of funding it gives to banks,” Uz said after the bank’s decision.

Despite an improvement in external conditions, currency risks remain and a higher late liquidity rate gives the bank added flexibility, Finansbank chief economist Gokce Celik, who accurately predicted the hike, said before the decision.

“The benefits of a late liquidity window rate hike at this time outweigh the costs,” she said.

— With assistance by Selcan Hacaoglu, and Inci Ozbek

(Updates with analyst comment in seventh paragraph.)
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