The Kapali Carsi

Rate hike at tomorrow’s Turkish monetary policy meeting?

Let me cut right to the chase: The Central Bank should hike rates, although even that may not work in controlling lira depreciation at this point. In any case, they probably won’t. I gave away any incentive to read on, but let me nevertheless explain.

Here’s the introduction to my latest Hurriyet Daily News (HDN) column, where I discuss whether the Central Bank of Turkey will be hiking rates at tomorrow’s (January 20) Monetary Policy Committee (MPC) rate-setting meeting. You already know what I think, but you can read the whole thing at the HDN website. I have a few extra points.

First, it is important to notice how quickly expectations change: At the Central Bank’s monthly survey of expectations, which was released on January 17, a rate hike was not being expected. In fact, there are no questions in the survey on the overnight lending rate, which serves as the new policy rate. But instead, there are five questions on one-week repo expectations, the interest rate formerly known as the policy rate, just like Prince:) However, the survey also asks “End of The Current Month’s BIST repo and reverse repo O/N interest rate (%)”. Respondents expect that interest rate, which is 7 percent at the moment, to be 7.4 percent at the end of the month. While that does not tell anything about rate hike expectations directly, the ceiling of the Borsa Istanbul (BIST) rate is the overnight lending rate, which is 7.75 percent at the moment. If they were projecting the BIST rate to be inside the current ceiling, they were probably not expecting a rate hike.

What is the market telling us? If we go back a couple of weeks, the yield curve inversion of January 6 was driven by rate hike expectations, although Finance Minister Mehmet “Nominal” Simsek argued soon afterwards that it reflected confidence in the economy. While it has not inverted since then, the backtracking in the yield curve on Friday reflected rate hike expectations according to market professionals. I talked to a few bond traders this morning, and they told me the bond market is pricing no rate hikes today (Monday, January 20).

Speaking of expectations, I mentioned in the column that out of the 18 economists surveyed in Turkish business channel CNBC-e’s more recent survey, 7 were expecting a rate hike, but it is actually a bit more complicated than that: 4 are expecting a 50bp hike, 2 75bp and 1 of them 100bp. This the first MPC meeting in quite a while where expectations have been so dispersed…

Moving on, a couple of words on terminology. The main argument in my column, as summarized in the fist paragraph I put above, is that the Central Bank should raise rates, but it will not unless it really has to because of political pressure by the government. But given that the lira’s freefall is continuing (USDTRY hit an all-time high of 2.25 today), there is now a very thin line between “choosing to” and “having to” hike rates. However, government officials seem as determined as ever to avoid a rate hike: Speaking over the weekend, the new Economy Minister Nihat Zeybekci underlined that neither the people nor the state had no intention of raising rates! As if it was Ernesto “Che” Guevera speaking- although I am sure that he doesn’t have 1/100th of Che’s “cojones”. He also said that a USDTRY of 2.25-2.30 would be beneficial for companies even though WSJ Turkey reported today (in Turkish) that firms are worried about the lira depreciation. So Zeybekci probably doesn’t know as much econ. as the medical doctor, either:) Anyway, I think someone did tell him it is the Central Bank that determines interest rates- as he toned down quite a bit today- he said he believed the Bank should not hike rates…

OK, what if I am wrong and the Bank raises rates? Will it make a difference? In the column, I said it probably wouldn’t, and so I need to expand on that: Well, the common argument in Turkey is that other countries that have recently been hiking rates did not manage to prevent their currency’s depreciation. Brazil, which recently raised rates for a seventh straight time, is usually given as example. One thing you have to remember with Brazil is that it hiked gradually; evidence on an emergency hike is more mixed. Granted, there is also the chance that a hike, gradual or sudden, could cause existing foreign investors in Turkey to panic and flee, but in any case, I would give more chance to a significant hike working in Turkey than a gradual one. But as I mentioned above, none of the economists surveyed by CNBC-e is expecting a hike of more than 100bp; a hike on that order may not be very effective.

But then again, it is also important to note that the real and the lira are depreciating because of inherently different reasons. As economist Atilla Yesilada noted, “Brazil’s problems are driven by foreigners leaving the real. TL’s problems are inspired by locals who care little about GEM, or political warfare in Ankara: They just want an honest return on their life savings.” I wouldn’t go as far as to say that politics is not having any effect on the currency, but as a matter of fact, FX deposits have been rising for quite a while:

Besides, there has not been an exodus from Turkish assets so far, as you can see from the weekly flows into equities and government bonds:

I would make two small small additions to Atilla: First, There has also been quite a bit of FX demand from the real sector since the summer. Second, this is not to say that foreigners have not been active. For example, today’s lira weakness was driven by big London names.

What does all this mean then? Well, first, higher rates will somewhat help dollarization. They could also attract capital flows, relieving real sector FX demand somewhat. They will surely help with inflation. That’s why I said in the first paragraph of the column that the Central Bank should raise rates, even though I don’t think it is the ultimate fix to the weak lira- it is just the best solution we have at the moment…

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