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ANALYSIS: Rate cuts will continue as corona-crisis places end of year inflation estimation within reach

22 April 2020

Higher then the general expectations, CBRT has cut its policy rate by 100bps to 8.75% at today’s MPC meeting, following a cumulative 1,425bp cut in the last 7 meetings. The weighted-average cost of central bank funding was already below the benchmark at around 9%.

Squeezed between a sharp slowdown in the economic activity and a 15% drop in the Turkish lira against the USD since the start of the year, the CBRT chose to act on the growth side.  The bet was of course on a landslide drop in the price of oil and contracting domestic demand that combine to ease inflationary pressures.

The lira at 6.9762 versus the USD ahead of the decision now trades from 6.9999. The currency is now of course further exposed to destabilization given that the current level inflation is at 11.9%.  The administration and the central bank see the end of year CPI inflation at 8.2%; which was unrealistic before the corona-crisis given the push for 5% GDP growth; yet which is now within reach after the expected sharp GDP contraction in the remaining quarters of 2020.

The central bank might even lower its year-end inflation projection at its next quarterly Inflation Report due on April 30.

Looking forward, the CBRT will thus see room for further rate cuts to 7.5-8% from the current 8.75% as President Erdogan seeks to support credit to ease the economic contraction from the coronavirus outbreak. The lira will be subject to further weakness surpassing the psychologically important 7-per-dollar mark; exerting threats on the financial stability front given Turkey’s 12 month forward looking USD170bn external debt payments mostly focused to the real sector.

Such a choice further pushes the Erdogan administration for establishing a swap line with the IMF or to a form of credit extension from the IMF as the lira will not be able to be supported through state baks’ interventions given the severe drop in Turkey’s international reserves. As Erdogan rejects the IMF option fiercely, if it materializes recovery in the Turkish lira against the USD could as well be expected towards 6.5 mark.

Below is the central bank press release following the 100 bps rate cut:

The Monetary Policy Committee (the Committee) has decided to reduce the policy rate (one-week repo auction rate) from 9.75 percent to 8.75 percent.

– As developments regarding the spread of the coronavirus substantially weaken global growth outlook, central banks in advanced and emerging economies continue to take expansionary measures. The pandemic disease is closely monitored for its evolving global impact on capital flows, financial conditions, international trade and commodity prices.

– Having displayed a strong upward trend in January and February, thanks to the improvement in financial conditions, economic activity has started to weaken in mid-March due to the effects of the coronavirus pandemic on external trade, tourism and domestic demand. In order to contain negative effects of the pandemic on the Turkish economy, it is of crucial importance to ensure the healthy functioning of financial markets, the credit channel and firms’ cash flows. In this respect, recent monetary and fiscal measures will contribute to financial stability and post-pandemic recovery by supporting the potential output of the economy. Current account balance, which recently recorded significant improvement, is expected to follow a moderate course throughout the year due to the restraining effects of commodity prices and imports.

– Developments in inflation expectations, domestic demand conditions and producer prices have contributed to a mild trend in core inflation indicators. Despite the recent depreciation in the Turkish lira due to global developments, continued sharp decline in international commodity prices, especially crude oil and metal prices, affects inflation outlook favorably. While the rise in unit costs resulting from declining production and sales is closely monitored, the disinflationary effects of aggregate demand conditions are estimated to have increased. In this respect, it is considered that risks on the year-end inflation projection are on the downside. Accordingly, the Committee decided to make a 100 basis point cut in the policy rate.

– The Committee assesses that maintaining a sustained disinflation process is a key factor for achieving lower sovereign risk, lower long-term interest rates, and stronger economic recovery. Keeping the disinflation process in track with the targeted path requires the continuation of a cautious monetary stance. In this respect, monetary stance will be determined by considering the indicators of the underlying inflation trend to ensure the continuation of the disinflation process. The Central Bank will continue to use all available instruments in pursuit of the price stability and financial stability objectives.

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