Turkey Macro Flash: CBT opts for another convoluted tightening

At the first MPC meeting of the year, the CBT kept both the interest rate corridor (3.5%-7.75%) and the one-week repo rate (4.5%) unchanged—an outcome which is in line with the consensus and our expectations. However, the CBT surprised the markets by announcing that interbank money market interest rates will materialize at 9.0% during additional monetary tightening days, instead of 7.75% (the marginal funding rate). This will be implemented through providing liquidity at 9.0% when deemed necessary. According to the Bank, the noted move aims at steering inflation toward the medium-term target.

Regarding price developments, the CBT notes that inflation indicators are likely to hover above the inflation target for some time due to the recent tax hikes and delayed effects of the exchange rate depreciation. In parallel, the Bank thinks that credit growth is on track to soften on the back of a more prudent monetary policy stance, macro-prudential measures and the reduction in capital inflows. Consequently, the CBT believes that the improvement in the current account balance (excluding gold) will continue in 2014.

In our view, today’s move signals the CBT’s recognition to tighten its policy stance in the face of rising depreciation pressures and the marked deterioration in the inflation outlook. From this angle, it is encouraging. However, we believe that the CBT’s move increases discretion further and raises unpredictability of monetary policy—both of which will likely lead to an increase in interest volatility and introduce an additional source of uncertainty to the pricing of Turkish assets. We believe that an outright increase in the upper band would have been more effective in terms of containing the currency depreciation and bringing inflation closer to the target.

 

All in all, we believe that today’s move will fall short of promoting FX stability and moving inflation closer to the target. We believe that the evolution of the lira and inflation will eventually lead the CBT to implement an outright rate hike through raising the upper band to 10.50% by the end of the year.