Lira Fate Hangs in Balance as Turkey Rate Decision Splits Street

(Bloomberg) -- It’s a moment of truth for Turkish markets, according to Morgan Stanley.

Analysts are divided on how the country’s central bank will set policy this Thursday in response to deteriorating inflation. Last month’s 300-basis-point emergency interest-rate increase hasn’t stopped a market rout fueled by fears that political pressure will keep a lid on rate hikes, and some investors say more are needed to restore confidence in the bank’s independence.

“The risk is they do nothing on political pressure, which would be very bearish Turkish assets,” said Lorenzo Gallenga, a fund manager at Quaestio Capital Management in Milan, who reduced his underweight position in the nation’s local-currency debt after last month’s rate increase. “I think that they will have to hike before the elections one way or another.”

The lira fell for a second day on Wednesday while benchmark local-currency bond yields surged to a fresh record high. Uncertainty over the outcome of elections on June 24, which could cement President Recep Tayyip Erdogan’s role in managing the economy, is compounding concerns over the direction of monetary policy and the currency.

Here is a look at what economists and strategists expect policy makers to do:

UniCredit SpA (Dan Bucsa)

  • Tighter fiscal policy needs to supplement monetary policy tightening to stabilize the lira, interest rates and inflation
  • “The central bank lacks credibility, battered by political interference and indecisiveness”
  • The CBRT cannot afford to turn much more dovish in the coming quarters; expects a 50bps hike in the corridor on 7 June

Morgan Stanley (Ercan Erguzel):

  • “We would expect the CBT to prefer to be on the conservative side and tighten its policy rate further by 75bp to 17.25%. Based on our new CPI forecasts, we expect another 75bp tightening in 4Q18 to 18.0% with the assumption that fiscal policy will start to tighten after the elections in June”
  • The central bank can also start funding lenders through O/N lending “if there is an ‘urgent’ need to make a change in the policy rate between two MPC meetings and adjusting the weekly repo rate accordingly (to the blended rate of the previous period) at the next MPC meeting”

JPMorgan Chase & Co (Yarkin Cebeci):

  • “May price data and ongoing credibility problems call for further tightening”
  • The bank has penciled in a 100bps hike by July; however it will not be surprised if the central bank delivers half of this tightening in its meeting on Thursday “to prevent further erosion in credibility”
  • “Although the government seems to be more vocal about the determination to take the necessary steps to bring inflation down, the sharp lira weakening and the worsening in inflation expectations have done significant damage to price dynamics”
  • Says “continuation of political tension or the emergence of a populist government could lead to further worsening in growth and price dynamics”

Goldman Sachs (Clemens Grafe):

  • Expects the central bank to keep rates on hold on Thursday, “but tighten its stance further by changing its funding mix going forward”
  • Says inflation will continue to increase and peak in third quarter “due to a combination of weaker lira, higher oil prices and base effects,” before ending the year at 13 percent
  • “We also think that inflation is likely to remain volatile, rise again temporarily at the beginning of 2019 and reach single digits only toward the end of 2019”
  • Still, “we think that the TCMB will try to avoid lira volatility ahead of the elections and respond to the market”

Nomura International Plc (Inan Demir):

  • “We expect a 100bps hike in the one-week repo rate to 17.50% at Thursday’s meeting, though we acknowledge a non-negligible possibility that the policy rate will be kept on hold”
  • Says the central bank “may well see the tightening it delivered in the extraordinary MPC meeting on 23 May as sufficient to address the deterioration in the inflation outlook”
  • “Alternatives to a hike could be keeping the one-week repo rate unchanged and funding the market through the O/N repo facility, whose rate stands at 18% or even hiking this rate to create more room to push the average funding cost for the banking system higher”
  • “However, we think such moves would be against the spirit of simplification that the TCMB announced so recently, and they would undermine the bank’s credibility”

Commerzbank AG (Tatha Ghose):

  • “Even if we assume that the lira will appreciate from here on, the impact of this surge on CPI will take several months to materialize and will probably drive core inflation into the 15 percent range before things stabilize”
  • “The real interest rate has to be significantly positive after assuming 15% inflation. Minor policy tweaks will not work. Can CBT deliver on 7 June irrespective of upcoming elections? And can we depend on the incoming administration to respect CBT’s decision? These are the big questions the market will soon ask”

ING (Muhammet Mercan):

  • “We do not rule out another rate response, albeit measured this time, possibly with a 50bps hike”
  • “If the CBT delivers a credibility reassuring hike this week, TRY will likely outperform in the near term, though uncertainty about the post-election policy mix will limit the gains”
  • “The unfavorable inflation dynamics, supply pressures and domestic political issues will likely keep yields in check in the near term”

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