JP Morgan: Will Central Bank cut rates further?
Given the short FX position of the corporate sector and the high external financing needs of the economy, lira weakness also poses risks to financial stability, and we expect the CBRT to consider this in next week’s rate decision
With another Central Bank of Turkey (CBRT) Monetary Policy Meeting coming up this week, the anticipation of further rates cuts is nearly a consensus. Foreks New Center polled economists who bet on a 50 basis rate cut. According to CBRT’s monthly survey of economic estimates 12 and 24 month forward CPI forecasts center on %9.7 and %8.62, which would warrant a neutral policy stance. Yet, inflation dynamics is not the only topic CBRT needs to mind when reaching a rate decisions. Despite state bank interventions in the foreign exchange market, dollar/TL closed the week at 6.95, which translates into a 16.5% depreciation of the local currency YTD. A looser monetary policy could add to currency pressures, raising specter of financial instability.
JP Morgan’s experienced Turkey research team recommends a cautious approach. Below are the excerpts from the report titled “Turkey: The CBRT could turn more cautious as the lira depreciates”:
The CBRT has cut rates in each of the last seven MPC meetings, bringing down the policy rate sharply to 9.75% from 24.0%. Importantly, the pace of easing has slowed steadily. The sharp slowdown in economic activity, a large negative output gap, weaker price pressures in global markets and at home, and the accommodative policy stance of major and peer central banks support the case for further monetary easing. However, EM central banks—in particular those in countries with large external vulnerabilities—also need to consider the risks to price and financial stability. In line with other high-yielding currencies, the pressure on the lira has increased significantly over the last few weeks. A weaker lira risks de-railing the disinflation. Perhaps more importantly, given the short FX position of the corporate sector and the high external financing needs of the economy, lira weakness also poses risks to financial stability, and we expect the CBRT to consider this in next week’s rate decision.
Would further easing help the economy?
We should also keep in mind that the CBRT has already introduced new funding mechanisms with interest rates lower than the policy rate. As a result, the CBRT’s effective funding rate is currently around 9.0%, 75bp lower than the 1-week repo rate. This effectively reduces the need for imminent easing. As a result, we expect the CBRT to deliver a mostly symbolic 25bp cut next week. Financial stability concerns could encourage the CBRT to pause while, given policymakers’ dovishness, the greater risk is a larger cut. We continue to expect the effective funding rate to fall to 8.0% by year-end.
How does the inflation outlook fare?
Given the uncertainties over the extent and the timing of the success in combatting the pandemic, it is extremely difficult to make forecasts on economic activity. March manufacturing capacity usage and manufacturing PMI figures (the only two data announcements after the start of the pandemic) were not alarmingly low. But, given the voluntary but widespread lockdown and the likely impact on travel and tourism, a plunge in economic activity is inescapable in 2Q.
We expect the recovery to be at a gradual pace in 2H and have recently revised down our 2020 GDP growth forecast to -4.5%. Such depressed domestic demand juxtaposed with weaker global commodity prices indeed imply continued disinflation and support the case for further easing.
Low oil prices limit exchange rate pass-through
March CPI data confirmed that sharply weaker demand restrained the FX pass-through and helped to keep the price pressures low. The plunge in global oil prices and the immediate reflection of this to local gasoline prices also contributed. We expect this trend to persist with weak demand and depressed global commodity prices offsetting the pressure coming from FX weakness in the coming months. We expect annual inflation to fall to single digits in July and end the year at 8.1% (down from our previous forecast of 8.4%).
Mind financial instability
As stated above, risks on financial stability created by sharp currency weakness is the main argument against further monetary easing. Given its external vulnerabilities and the recent lira weakening, this argument is a strong one for Turkey. The pace of lira weakening has indeed picked up in recent weeks. The lira lost 2% of its value against the US dollar in the first two months of the year but then lost another 14% since the start of March.
True, Turkey has gone through a period of substantial external rebalancing and deleveraging. The current account has improved from a deep deficit to a surplus and companies have paid back significant amount of external debt. However, the total external debt obligations coming due over the next 12 months is still as large as US$170 billion and the non-bank private sector still has a short FX position of US$175 billion. Hence, continued lira depreciation could potentially lead to concerns over financial stability and could hurt policy credibility. To be fair, almost all EM currencies are under pressure, but we think that this is still a strong argument for a more cautious policy stance.
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