Big Cut Or a Hold to Stun Doubters? Turkish Rates Scenarios
A Big Cut Or a Hold to Stun Haters? Scenarios for Turkish Rates
(Bloomberg) -- Now that investors have had a few days to digest President Recep Tayyip Erdogan’s indisputable influence over the central bank, the question is: how fast will Turkish borrowing costs fall?
Even before Governor Murat Cetinkaya was replaced by his deputy, the market had given policy makers the green light for Turkey’s first rate cut in three years. That view has held this week despite the lira’s biggest drop since early May on Monday.
But the speed with which the monetary authority loosens financial conditions will make a world of difference for the market, given Erdogan’s well-documented distaste for high interest. A tempered approach would give way to capital inflows that support the lira and help inflation slow, while a more aggressive stance risks derailing the currency’s nascent recovery.
The lira fell to a session low of 5.7580 per dollar on Wednesday after Erdogan said Cetinkaya was replaced for not following his instructions. “You will soon see how interest rate policy will be shaped,” he said. Central bank officials will decide on rates July 25. So what are the scenarios?
A Massive Cut
The biggest concern for investors is whether Erdogan will force the central bank to cut rates too aggressively and too quickly. By the end of last week, markets had already priced in a hefty easing cycle, with one-year lira cross-currency swaps trading about 450 basis points below the benchmark policy rate of 24%. That hasn’t changed much.
Judging by the steepness of the curve, however, what has shifted are investor expectations over how fast the central bank will cut. Short-end rates have plummeted this week, while borrowing costs are rising further along the curve, a sign that investors are looking to protect themselves against a pickup in inflation. Consumer price growth slowed to 15.7% in June.
“It seems that President Erdogan intends to address economic woes of persistently high inflation by lowering interest rates relatively quickly instead of focusing on much more unpopular and therefore more difficult to implement structural reforms,” said Piotr Matys, an emerging-markets strategist for Rabobank.
Governor Murat Uysal “may opt for a large cut of a few hundred basis points” to appease Erdogan, he said.
Take Baby Steps
Given the damage inflicted on the central bank’s credibility by Cetinkaya’s ouster, Uysal may opt for a measured drop in borrowing costs to alter the narrative a little. A 100-basis point cut in the one-week repo rate, as estimated by Standard Chartered Plc’s Carla Slim last week, would be a sign of restraint when investors suspect it least. She’s sticking with that forecast.
“Despite conditions being conducive, the CBRT this year has delayed the start of the easing cycle due to market turbulence,” the Dubai-based economist said by email. “A sharp initial cut in July could unnerve markets and in turn potentially hinder the central bank’s maneuverability in following through with further cuts. Hence, we continue to expect gradual easing.”
Prove Doubters Wrong
Keeping rates unchanged would stun analysts and investors worldwide, possibly leading to a rally in the lira. If inflation slows as expected over the coming months, it would also increase Turkey’s real rate, already the highest in the world.
Read More: Turkey’s Real Rate Now Towers Over Peers
“Since September, the central bank held monetary policy as a sign of its independence against government interference,” said Sebastien Galy, a senior macro strategist at Nordea Investment Funds in Luxembourg. “If it holds rates this month despite expectations of an aggressive cut, it would calm investors after a bout of volatility in the equity and fixed income market.”
The logic would also be that “as price pressure eases so does the need to fight against it,” according to Galy, although he, like most strategists, thinks the scenario is unlikely.
To contact the reporter on this story: Dana El Baltaji in Dubai at delbaltaji@bloomberg.net
To contact the editors responsible for this story: Justin Carrigan at jcarrigan@bloomberg.net, Constantine Courcoulas, Paul Abelsky
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