Turkish central bank hikes rates by 50 bps, likely to tighten policy again in 2018

The Turkish central bank, CBRT, hiked its interest rate by 50 basis points today, following the sharp depreciation of the Turkish lira in the autumn and consequently rising inflation. The hike made today in late liquidity window lending rate was considerably lower than what markets anticipated. It was a widespread disappointment as it again spurred investors’ worries regarding the CBRT’s focus on bringing inflation back to the target, not least by guaranteeing more stability in currency, noted Nordea Bank in a research report.

As President Erdogan exerts pressure on the central bank for not hiking the rate anymore to underpin growth, today’s move might resemble a compromise hike. The funding costs would be hiked by nearly 50 bps, but that is too little to change the actual market perception that CBRT is unwilling to do enough to underpin the currency, stated Nordea Bank.

Meanwhile, the CBRT has expressed its readiness to further tighten the monetary policy, if new data impacting inflation will deteriorate more and ensured markets that it will “continue to use all available instruments in pursuit of the price stability objective”.

“In our view, a lack of further hikes in late liquidity window in early 2018 is likely to weaken the lira further and, in turn, make it even more unlikely that the CBRT meets its inflation target for the first time”, said Nordea Bank.

Political risks in the country are at a higher level and are expected to stay high, which signifies that the overall volatility in TRY is expected to stay at the current, high level. The CBRT is expected to reiterate the tightening in 2018, but at a very slow rate, according to Nordea Bank. Even if inflation is expected to fall in the first half of 2018 because of favorable impacts from the FX pass-through in the start of this year, additional strong acceleration is expected in the second half of 2018. This would signify that the central bank will continue to be trapped in the vicious cycle of not giving support to the currency, which boosts the future inflation and creates requirement for additional support.

“If we are right with CBRT not providing enough support in 2018 as well, the TRY is likely to weaken further next year. An emergency hike of around 100-200bps at the next meeting or a significant drop in inflation is likely to be needed to break the weakening trend”, added Nordea Bank.

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