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OPINION: The obsession with low rates carries big dangers

13 December 2019

Turkey is rapidly swimming towards the shark-infested waters of single digit interest rates, despite rising inflation and sundry conflicts with US and EU, which may reflect poorly on exchange rate stability.  On Thursday economy czar Berat Albayrak heralded that state banks will launch single digit loans at the turn of the year.  Turkish brokerage house Yatirim Finansman Invest and JP Morgan, too, expect rate cuts to continue  to support cheaper loans.     How will this policy impact the current account and inflation?


CBRT MPC – No clear signal on life-cycle of easing policy

CBRT lowered its policy rate by 200bps to 12.0% from 14.0% vs. market expectation of 100-200bps and our expectation of 175bps.

One can interpret the appreciation of TL post-MPC decision as a result of tail-risk of an even a deeper rate cut having been ruled-out, commented  the research team at Yatirim Finansman.

The daily note continues as follows:  If one looks into the accompanying commentary, CBRT did not change its wording with respect to the interaction of its monetary policy and inflation outlook. The Committee kept the operative statement “At this point, the current monetary policy stance is considered to be consistent with the projected disinflation path” unchanged from the previous MPC statements.

CBRT additionally embellished on the outlook suggesting that “recent forecasts suggest that inflation is likely to materialize close to the lower bound of the October Inflation Report projections for the end of the year, with risks around the disinflation path for 2020 being balanced”.

This means that CBRT has even higher conviction that trend inflation remains anchored at 8.0-8.5% vs. our more conservative view of around 9.5-10.0%. Therefore, CBRT may not stop easing at 11.0% in 1Q20 as we predicted before. Hence, depending on December inflation realization (YFe 0.45% MoM), we may have to revise down our policy rate expectation for 1Q20 and beyond towards 10% (which is likely to occur in 1Q20, possibly in January). Hence, we acknowledge there is significant downside to our terminal rate expectation of 11.0% in 1Q20.


JP Morgan:  Easing to continue albeit more gradually



JP Morgan Turkey team wrote:  There is no meaningful change in the interest rate announcement note and the main policy guidance sentence remains unchanged. This suggests that the CBRT is not planning to halt in the coming months.

We believe that a supportive global financial backdrop, weak price pressures, a negative output gap and a stable lira support the case for a more front-loaded easing cycle than we initially envisaged. The pace of easing will surely decrease and the fact that the number of PMC meetings per year will increase to 12 from eight will help the CBRT to slow down. We now expect 50bp cuts in monthly MPC meetings in the coming months. We see single-digit policy rate as early as in July and we expect the policy rate at 9.0% (down from 9.5% previously) at the end of 2020. If growth disappoints and/or geopolitical risks subside, the CBRT could deliver more. Conversely, a sharp worsening in external balances that could follow a rapid recovery in domestic demand and increased geopolitical vulnerabilities could start pressurizing the lira and hence urge the CBRT to be more cautious.


Risks to excessive easing


Cutting ahead of actual disinflation raises the specter of a silent run on FX deposits, as two surveys indicate participants believe Turkstat inflation data understates the truth. Thus, the perceived real rate of interest on TL deposits is sharply negative, which has accelerated dollarization. The next step could be withdrawal of FX deposits to insure against the risk of arbitrary conversion into TL assets.


The carry trade is one of the few venues of  financial flows in Turkey, which will be  desperately needed in 2020, as the current account swings  from the current ca $5 bn surplus into a deficit of $14-15 bn. Reducing the yield differential with dollar and Euro could dry up carry flows, exerting upward pressure on the exchange rate.


Finally, Ankara simply doesn’t believe that US Senate or EU could legislate hurtful sanctions because of the various conflicts in progress.  These could unfortunately materialize quickly, as President Erdogan elevated defiance of the “West” to an important pillar of his policy plank to gain the march on his new rivals Ali Babacan and Ahmed Davutoglu.  Such sanctions could raise TL option volatility, or reduce Turkish banks’ ability to borrow abroad, once again causing a currency shock.


It is simply not smart to leave the currency completely defenseless in favor of more growth, when Turkey is still dancing on a knife’s edge, economically and diplomatically speaking. Neither is it desirable to inundate the economy with monetary stimulus  while current account deficits and inflation have been beaten only because of the deep recession.


Atilla Yesilada


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