The CBRT surprised markets with a 200bps hike today, bringing the one-week repo rate to 19%. Markets had expected a 100bps hike heading into today’s MPC meeting, with the swaps market and 23 of the 24 economists surveyed by Bloomberg projecting a 100bps hike (with the lone outlier projecting no hike at all). The TRY was c2% stronger in response to the hike at the time of writing.
Today’s MPC decision was a key moment for the TRY, with volatility rising heading into the announcement. This reflects the binary nature of the MPC decision, with markets anticipating TRY strength in the event of a hike or a sharp selloff if the CBRT failed to deliver. Dollar-lira implied volatility climbed yesterday to the highest level since 18 November, the day before newly appointed Governor Naci Agbal’s first MPC meeting during which the policy rate was hiked by 475bps.
The decision comes against the backdrop of rising inflation and inflation expectations, with the MPC statement saying that “domestic demand conditions, cumulative cost effects, in particular the exchange rate effects, increasing international food and other commodity prices and high levels of inflation expectations continue to affect the pricing behaviour and inflation outlook adversely.” As a result, “the MPC has decided to implement a front-loaded and strong additional monetary tightening.”
Today’s decision pushes the real interest rate from 1.4% to 3.4% and will help stem recent pressures on the TRY, which in turn risked passing through to an even worse inflation outlook. The statement says that “the balance between the monetary policy rate and actual/expected inflation will be sustained decisively to maintain a strong disinflationary effect until permanent price stability and the 5 percent target are reached” and that “additional monetary tightening will be delivered if needed.”
While today’s hike is welcome news, the MPC noted that “strong domestic demand due to the cumulative effects of high credit growth during the pandemic and the rise in import prices continue to adversely affect the current account balance. On the other hand, credit growth, which has slowed down amid tighter financial conditions, has recently trended upwards.” As such, the tight policy stance must be sustained to permanently rein in inflation and external imbalances.
The TRY had come under pressure in recent weeks, which was partly a reversal of its world-beating 22.5% return from November to February amid rising global risk aversion and US rates, and partly driven by rising concerns about the CBRT’s ability to stay the course on tight monetary policy amid resistance from President Erdogan. As a result, the TRY was nearly 8% weaker relative to its mid-February peak heading into today’s meeting.
President Erdogan has in recent days seemingly tried to alleviate some of those concerns, culminating in a policy speech on Friday in which he said the government was committed to reining in spending and is prioritising efforts “to achieve single-digit inflation.” Specific policy plans include the creation of a price-stability committee, indexation of public sector price and tax increases to inflation targets, and increasing the issuance of TRY-denominated bonds.
He also said that Turkey would abolish extrabudgetary spending and reform the public tender process in an effort to achieve a budget deficit of 3.5% of GDP this year, largely unchanged from last year’s 3.4% deficit but narrower than the 4.3% target laid out in October. Expanding on the concept of a price-stability committee, Finance Minister Lutfi Elvan said the government “won’t interfere in competitive price mechanisms” and will focus on supply shock issues to complement and support monetary policy.
But despite Erdogan’s reassurances, the recent TRY selloff speaks to the difficult road the CBRT must travel to rebuild credibility with the markets. After years of policy reversals and spiralling inflation, credibility will not be earned overnight and even the slightest whiff of political pressure from Erdogan threatens to send the TRY into another tailspin. And the longer rates stay high, the more pressure Erdogan will feel to stoke growth with another credit boom.
In addition, it will take time for the CBRT to bring inflation down to single digits. Abdurrahman Kaan, head of the business group MUSIAD, recently said that price increases stemming from global markets are “outside the sphere of influence” of the central bank and that the “impact of tight monetary policy on inflation has somewhat diminished.” With global commodity prices continuing to rise, it is true that cost-push factors are a major driver of recent price increases. Clearly there is a huge domestic component as well, but the supply-side narrative could increase public pressure on the CBRT to cut rates.
As difficult as it will be for the CBRT to regain the trust of foreign investors, domestic investors may be even harder to convince. Dollar deposits and gold imports have begun to come down in recent months but remain high, with local scepticism about the durability of the CBRT’s policy shift still rampant. This has added pressure to the currency and reserves, with the Trade Ministry recently proposing a draft bill that obliges jewellery stores to deposit 500 grams of gold each (totalling c20 tons) with state lenders in a bid to bring more gold deposits into the financial system and boost reserves.
Today’s MPC decision is undoubtedly positive, further solidifying the CBRT’s shift towards orthodoxy and greatly reducing pressure on the TRY. However, the longer high rates are sustained the more pressure there will be to reverse course, as Turkey’s credit-fuelled growth of recent years gives way to a more modest recovery. For the time being, at least, the CBRT has provided some welcome reprieve for the TRY; we retain our Buy recommendation on Turkish T-bills.
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