Turkey Forgoes Rate Hike, Sets Stage for More Stealth Tightening

(Bloomberg) -- Turkey raised the upper bound of its interest-rate corridor but unexpectedly left its benchmark on hold on Thursday, risking further volatility in the lira as the central bank sticks with its stealth tightening to contain the currency’s weakness.

While the Monetary Policy Committee left its key one-week repo rate at 10.25%, a move forecast by just two of 27 respondents in a Bloomberg survey, it raised the late liquidity lending rate to 14.75% from 13.25%.

That doubled the gap with the central bank’s overnight lending rate to 300 basis points, creating more room to raise the cost of lira funding daily without resorting to outright tightening.

The lira weakened as much as 2.1% against the dollar after the decision, sliding to a record low of 7.9797, before recovering some of the losses. It was trading down 1.5% at 7.9274 as of 5:26 p.m. in Istanbul.

“The wider corridor leaves ample room to tighten policy further but indicates the transitory nature of the recent policy shift,” said Maya Senussi, senior economist at Oxford Economics. “In the absence of a credible policy, the lira’s troubles will continue.”

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Governor Murat Uysal had surprised investors last month by increasing the key rate by 200 basis points, a move that ran counter to President Recep Tayyip Erdogan’s demand for cheaper borrowing. The central bank has since tightened policy further by restricting funding at the benchmark rate, forcing lenders to use costlier options.

But the approach hasn’t arrested the currency’s fall: the lira continued to drop after the September rate decision, a period in which most major world currencies gained.

Just hours after the decision and before the higher rate went into effect, lenders borrowed 28 billion liras ($3.5 billion) from the so-called late-liquidity window, typically used for emergency funding, at 13.25%.

Since ceasing to provide liquidity at its cheapest rate by suspending one-week repo auctions in August, the central bank has effectively been tweaking the cost of funding on a daily basis, modifying the amount of liquidity available to lenders across its various rates.

Using backdoor channels to contain the currency’s weakness, the bank has raised the weighted average cost of funds to 12.52% on Wednesday from as low as 7.34% three months earlier.

The tightening follows 1,575 basis points of easing in nine consecutive steps until June, which left Turkey’s inflation-adjusted borrowing costs among the lowest in the world but helped the government provide support to the $740 billion economy during the pandemic.

The latest move suggests the monetary authority is likely to maintain its backdoor policy setup.

“Political pressure is clearly making Turkey’s central bank reluctant to enact further conventional rate hikes,” said Jason Tuvey, senior economist at Capital Economics in London, one of the two forecasters who correctly predicted the decision. “This will inflict fresh damage to its credibility and raises the risk of more abrupt falls in the lira.”

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