Turkey’s turmoil slows down pace of interest rate cuts

Bloomberg

Turkey’s central bank slowed the pace of interest rate cuts at its meeting on Tuesday after the failed coup attempt triggered a sell-off in the currency and sovereign debt.
The bank lowered its overnight lending rate by 25 basis points, which fell short of the 50-basis-point cuts it delivered during the past three meetings but matched the median estimate in a Bloomberg survey. The one-week repurchase and overnight borrowing rates were kept at 7.5 percent and 7.25 percent respectively, the bank said in a statement.
The rate setting Monetary Policy Committee led by Governor Murat Cetinkaya opted for a “measured and cautious step” due to volatility in financial markets, according to the statement. Citing heightened political risk after this weekend’s botched attempt by the military to overthrow the government, several economists revised their predictions, taking the median survey forecast to a quarter-point cut in the overnight lending rate instead of 50 basis points previously.
“It was a step that increased the central bank’s credibility because it was in line with market expectations,” said Bora Tamer Yilmaz, an economist at Ziraat Invest in Istanbul, one of those to halve his prediction to a 25-basis-point reduction. “Now we have a new central bank expression: measured and cautious, which means 25 basis points.”

Confidence Shattered
The rate-setting committee trimmed the measure — the upper limit of a range used by the central bank — by 50 basis points in each of the past three months amid a favorable global backdrop. Yet investor confidence was shattered on Friday night when tanks rolled in Ankara and Istanbul before authorities eventually restored order. And while the currency pared losses on Monday, bonds tumbled and the cost of insuring the country’s debt soared.
The central bank on Sunday pledged to provide unlimited liquidity to lenders, and said it would support the lira by removing the limits on foreign-currency deposits that commercial banks are allowed to use as collateral. Deputy Prime Minister Mehmet Simsek, a former Merrill Lynch banker, urged investors not to panic, saying Turkey’s economic foundations remained “solid.”
“Recently, domestic developments have led to fluctuations in financial markets,” the central bank said in Tuesday’s statement. “The committee assesses that the recent liquidity measures have alleviated the volatility in financial markets.”

Ratings Review
Although the coup failed, its occurrence reflects the political challenges that Turkey faces, Moody’s Investors Service said Monday. The credit rating company kept Turkey at investment grade, as did Fitch, but put it on review for possible downgrade to junk status, citing the takeover attempt’s potential impact on growth, policy making and Turkey’s ability to finance its external imbalances.
The lira surged as much as 3 percent on Monday, before giving almost half of its gains back by 10:30 p.m. in Istanbul. The benchmark Borsa Istanbul 100 Index for stocks, which had closed before the clashes began, dropped 7.1 percent, the most in three years. Yields on 10-year government bonds jumped 64 basis points, their biggest advance since 2013. The currency gained 0.1 percent to 2.9795 per dollar at 2:42 p.m. on Tuesday.
The lira’s slump and Turkey’s rising risk premium may force policy makers to maintain rates for now, but their inclination to cut remains in place, according to HSBC economist Melis Metiner.
“We would expect the easing cycle to resume if and when the lira stabilizes,” Metiner said in an e-mailed note a day before the rates decision. Her original call was for a 50 basis-point cut to the overnight lending rate.
The bank lowered the lending rate four times since March, bringing it to 9 percent last month, while keeping the one-week repo and overnight borrowing measures unchanged. Tuesday’s cut took the bank’s so-called interest-rate corridor to its narrowest point since the system was introduced in 2010. Lower global volatility has diminished the need for a wider rates corridor, Cetinkaya said in April.
Clemens Grafe, a Moscow-based economist at Goldman Sachs said before the rates decision that events over the weekend may have reminded the governor “that a too-narrow interest rate corridor is undesirable as it restrains the bank’s policy space to react to shocks without resorting to emergency rate hikes.” Grafe, who had initially forecast a half-point reduction, said Monday that the bank might instead hold all rates.