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Turkey Removes Cheaper Funding But Erdogan Urges Lower Rates

Turkey’s Recep Tayyip Erdogan wants interest rates cut further, after the central bank held the line in July.

Turkey Removes Cheaper Funding But Erdogan Urges Lower Rates
Recep Tayyip Erdogan, Turkey's president, arrives ahead of talks in Brussels, Belgium. (Photographer: Geert Vanden Wijngaert/Bloomberg)

The Turkish central bank took another step to raise the cost of money without resorting to outright increases in interest rates.

A day after the latest call from President Recep Tayyip Erdogan for lower borrowing costs to boost economic growth, the central bank reduced the cheaper liquidity it provides to primary dealers as part of its open market operations to zero from Aug. 12, according to a statement on Tuesday.

Primary dealers, or firms that trade directly with the Turkish central bank, already had their liquidity limits halved on Monday. The lira erased losses after depreciating as much as 0.9% earlier in the day.

Turkey Removes Cheaper Funding But Erdogan Urges Lower Rates

The decision is effectively a backdoor way to tighten monetary policy because it’s expected to push the central bank’s weighted average cost of funding higher. While it’s at odds with Erdogan’s call for lower rates after upheaval in financial markets sent the lira to a record low against the dollar, the workaround solutions might not provoke the president as much as a hike in Turkey’s benchmark.

Turkey Removes Cheaper Funding But Erdogan Urges Lower Rates

Facing pressure to tighten policy, the central bank is now moving back toward a more complicated regime of multiple rates that had confounded analysts and investors. Last week, it ceased to provide liquidity at its cheapest rate of 8.25% by suspending one-week repo auctions.

“The problem with this kind of tightening is that it is flexible, and seen as temporary,” Timothy Ash, a strategist at BlueBay Asset Management LLP in London, said by email. “The market needs to believe that the central bank is going to tighten policy and keep policy tight for an extended period.”

Rate Corridor

The latest move forces all local lenders to meet their funding needs through the overnight window at a rate of 9.75%. Should the central bank follow the playbook it used to cope with a currency crash in 2018, the next step could be to push the cost of money to 11.25% by turning to its late liquidity window.

The central bank’s weighted average cost of funding rose by 60 basis points over the past week week to 8.32% on Monday. It moved above 8% on Friday for the first time since late May.

The challenge for Governor Murat Uysal is how to navigate the competing demands of the presidency and investors. The Turkish leader is a firm believer that high borrowing costs fuel inflation. Most economists and central banks around the world believe the opposite to be true.

The central bank held the line in July for a second month following a series of reductions that brought the key rate down to 8.25% from 24% in July 2019. Erdogan fired Uysal’s predecessor a year ago for not easing policy.

“God willing, they will go down further,” Erdogan said in a televised speech in Ankara on Monday, referring to interest rates. “That’s our wish, so that investors can invest in this country in an easier and stronger way.”

The lira was trading little changed at 7.2810 against the dollar at 11:54 a.m. in Istanbul. It’s lost over 18% against the the U.S. currency since the beginning of the year, making it the worst performer in emerging markets after the Brazilian real and South Africa’s rand.

“The base rate needs to be increased,” Ash said. “But we all know Erdogan cannot tolerate this. The price? Another stop-go economic cycle and a huge waste of FX reserves defending the exchange rate.”

©2020 Bloomberg L.P.