Turkish central bank slashes rates 425bps in first shift since crisis

Turkey’s central bank sharply cut its key interest rate by a more than expected 425 basis points to 19.75% on Thursday to spur a recession-hit economy, its first step away from the emergency stance it adopted during last year’s currency crisis.

The bank lowered its benchmark one-week repo rate from 24%, where it had remained since September, when a collapse in the Turkish lira pushed inflation to a 15-year high above 25%, prompting aggressive rate hikes.

Inflation has since dropped below 16%, opening the door to the first monetary easing in four-and-a-half years in the Middle East’s largest economy.

The lira, which has been volatile this year after a nearly 30% drop in 2018, tumbled immediately after the policy announcement to as much as 5.78 against US dollar. But it quickly bounced back to 5.66.

The central bank, whose credibility has been questioned anew by investors after its chief was abruptly sacked this month, said the inflation outlook continued to improve.

“Maintaining a sustained disinflation process is the key for achieving lower sovereign risk, lower long-term interest rates, and stronger economic recovery,” it said in a statement. “Keeping the disinflation process in track with the targeted path requires the continuation of a cautious monetary stance.”

Economists expected a median cut of 250 basis points, or 2.5 percentage points, according to a Reuters poll last week that showed a wide range of views.

The lira has steadied in recent weeks, even though Turkey faces the threat of US sanctions over its purchase of Russian S-400 missile systems. That stability, along with a recent dovish shift among the world’s major central banks, also paved the way to the easing.

The bank’s new governor, former deputy Murat Uysal, took the reins after Turkish President Tayyip Erdogan fired his predecessor, Murat Cetinkaya because as Erdogan said he failed to follow the government’s policy instructions.

Reuters, citing sources, later reported the president sacked Cetinkaya a year before his term ended because he resisted requests for a 300-basis-point cut, which prompted some analysts to predict an even sharper easing on Thursday.

A Reuters poll before Uysal took over found economists expected only a 100-basis-point cut.

“We don’t expect this positive sentiment towards risky assets to prove sustainable,” said Piotr Matys, EM FX strategist at Rabobank. “Perhaps today the central bank can get away with such a substantial rate cut, which might actually encourage them to do the same amount of cutting at the next meeting.”

Political pressure

The policy stimulus could help lift Turkey’s economy from recession, reduce its 13% unemployment rate and relieve borrowers who had faced some of the highest real interest rates in the world’s emerging markets.

Inflation dropped markedly last month to its lowest level in a year at 15.7%, sealing expectations for the cut. On Thursday the central bank said inflation “displayed a significant fall” in the second quarter.

Turkey’s $766-billion economy began contracting last year after the currency crisis was sparked by a diplomatic spat with the United States, a build-up of cheap foreign debt, and worries over the central bank’s independence from Erdogan who has repeatedly called interest rates “evil.”

A sharp drop since then in the current account deficit and the broader shift by the US Federal Reserve and European Central bank to a more accommodative stance has helped stabilise the lira, which earlier this year briefly sold off again.

But the new rift with Washington over the purchase of S-400s has set the stage for sanctions that could again rattle the currency, prolong the recession, and halt the central bank’s plans for more rate cuts.

Erdogan, who suffered stinging local election setbacks this year thanks in part to his handling of the economy, has repeated contrary to monetary theory that tight policy sparks inflation.

Uysal, who has been one of the bank’s more dovish policymakers, said shortly after taking the reins “there is room for manoeuvre in monetary policy.”

Former governor Cetinkaya hiked rates by 625 basis points in September in a move that many investors saw as too late. Still it helped stem further losses in the lira and put a lid on inflation, even while it helped push the economy into recession.

After Cetinkaya’s dismissal early on a Saturday morning this month, the three major ratings agencies warned about political interference and Fitch cut Turkey’s sovereign rating further into junk territory.

Source: moneyweb.co.za