Turkey’s central bank seen staying difficult course

ANKARA / Reuters

Turkey’s central bank will stick with unorthodox measures to keep borrowing costs at five-year highs at least until inflation peaks this year, according to people familiar with its thinking, despite sharp criticism from investors.
The bank has long puzzled markets with a complex system of setting policy through multiple interest rates but it ratcheted up the difficulty last month by introducing new liquidity measures to shore up the sagging lira currency.
While investors would prefer more decisive and transparent rate increases, the moves appear to be working. The weighted average cost of funding climbed to 10.37 percent last week, the highest since the middle of 2012, and the lira has stabilised, with some help from the easing US dollar.
The central bank is now likely to stay the course and keep funding costs stable until inflation crests, anticipated in or around April, according to three people who declined to be identified because of the sensitivity of the matter.
Annual inflation, which was running at 9.22 percent in January, is expected to reach double-digits in the coming months but slacken off in the second half, economy officials have said.

BALANCING ACT
Turkey’s central bank has an unenviable task. It must try to balance the demands of investors, who want substantial rate rises to tame inflation, with those of President Tayyip Erdogan, who has declared that he is an “enemy” of interest rates and called for cheaper credit to stimulate consumption and revive the economy.
The reliance on liquidity moves, such as cutting off funding taps, has deepened investor concern that the bank is loath to raise rates outright because of pressure from Erdogan.
Some market players expect Erdogan’s criticism of interest rates to become more frequent in the run-up to an April referendum that he counts on giving him the broad presidential powers – authoritarian, his foes fear – that he has long sought.
Divisions among Turkey’s economy team have also hampered monetary policy and unsettled investors.
Some officials, keen to preserve Erdogan’s reputation for delivering strong growth, insist Turkey cannot afford rate increases with the economy slowing at its sharpest pace in almost a decade. Others disagree and say politicians should be quieter about monetary policy, even if this means higher rates to steady the lira and restrain inflation.
At its most recent policy-setting meeting last month, the central bank raised two of its interest rates, but kept its benchmark one-week repo rate on hold at 8 percent.

JURY STILL OUT
“The jury is still out on whether this is going to be enough. They’ve gotten lucky essentially over the last few weeks with the markets settling down and taking a more (emerging markets)-positive stance,” said Manik Narain, a UBS strategist.
“The true test is going to come if the dollar starts to appreciate again or, more broadly, (when) you get volatility rising in EM.”
After double-digit declines in 2015 and 2016, the lira was hammered in January – falling as much as 10 percent at one point in the month. While it has recouped some losses, it is still one of the worst performing emerging market currencies this year.
The bank’s unusual liquidity measures have brought suggestions from Turkish market players that it is reviving some of the policies of ex-Governor Erdem Basci, the architect of its so-called “interest rate corridor” of multiple rates. Under Basci, there were relatively wide differences in the weighted average cost of funding from day to day.

However, Murat Cetinkaya, the current central bank governor, has said there would be no return to the “wide corridor” of old.
“Exceptional daily measures like in the past, such as tight one day and loose the other, should not be expected,” said the first person versed on central bank thinking. Still, it remains to be seen whether that will be enough to appease investors.
“Their actions are betraying a lack of conviction,” Narain of UBS said, adding that an outright rate hike would reassure markets that the bank was serious about tackling inflation.
“It’s one thing doing it for three days, it’s another doing it for three months or longer and really sending a signal they will do whatever it takes to bring inflation back down.”