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Stubborn inflation, shaky lira forces Central Bank’s hand

"To cut or not to cut, that is the question for CBRT"

Stubborn inflation, shaky lira forces Central Bank’s hand

Amidst rising noise from Ankara that interest rates are too high to sustain growth, Turkey’s Central Bank (CBRT) refused to lower any of its policy rates, remarking that it might have to resort to additional monetary tightening, if needed.

According to GlobalSource Partner’s Turkey economist  Dr Murat Ucer: “As far as (MPC)  the statement is concerned, there are two changes in wording regarding references on growth and inflation, with the Bank now talking: 1) stronger than expected growth (“recovery in the economic activity has gained strength” in the current statement, from “ongoing recovery” previously) and 2) worse than expected inflation dynamics, with an explicit reference to core inflation in today’s statement (“elevated levels of inflation and developments in core inflation indicators pose risks on the pricing behavior”).

AKP can still compel CBRT to lower its “effective policy rate”, which is the daily blended interest rate it charges to banks which borrow money in the open market operations, but for now the Bank is running scared of roaring inflation.  One might add, given the high pass-through from currency depreciation to inflation it also doesn’t desire a weaker lira, which –as luck would have it—received a minor blow from Trump’s tax reform hype and the interest rate pressure from AKP in the days preceding the MPC meeting.

PAIntelligence surveyed the reports of major investment banks to divine the direction of monetary policy and inflation in the coming months. There will be easing and improvement, respectively, but only gradually and relatively.

Nomura:  Shaky TL calls for caution in liquidity management

As expected, the TCMB kept all policy rates unchanged and reiterated that further tightening will be delivered if needed. This should come as a relief to the FX market which was concerned by the risk of a premature shift in policy stance following recent calls for a weaker currency. Beyond the immediate relief, the pressure on TRY that followed the sharp drop in offshore O/N rates earlier this week shows how precarious the risk-reward profile for TRY is, and this calls for utmost caution in the TCMB’s liquidity management going forward.

Goldman Sachs:  No easing in 2017

The average cost of funding has been stable at around +12.0% since April. Given our forecast that inflation will peak at around +11.5% in October, end the year around +10.0% and remain in the elevated single digits going into 2018, we expect the TCMB to maintain its current tight stance in the months ahead. We think the TCMB will ease policy only when inflation starts coming down in 2018 by lowering the average cost of funding and increasing liquidity, rather than rate cuts.

Morgan Stanley:  Dollar/TL to rise in the remainder of the year

We expect the CBT to keep policy rates at current levels in the rest of the year while keeping the blended rate stable around 12%. We see CPI easing to 9.8%Y by December and further to 8.3%Y by next March, with the assumption of USDTRY at 3.60 by year-end. This is likely to provide the CBT with room to ease its blended funding rate by around 200bp towards around 10% by 1Q18. We expect the CBT to ease its monetary policy stance by changing the composition of its daily funding, without making any change to actual policy rates.

Inflation sticky at 8%, inflation target forgotten

From the investment banking research presented above, one gets the impression that CBRT’s mission of reducing inflation to  5% is forgotten in the sense that monetary policy will be eased immediately once CPI drops to single digits.

The weakness of this approach is pricing habits becoming stickier each year, with economic agents using periods of strong domestic demand to escalate price or wage hikes. The government’s habit of indexing everything from court fines to wages and pensions to inflation broadens stickiness to the entire economy. With budget deficits rising to an estimated 2.5% of GDP in 2017 and no less than 2% in 2018, achieving the 5% inflation target any time in the foreseeable future is not possible.

The currency: At the mercy of the EM risk appetite

Major investment banks and most Turkish analysts believe TL is one of the most undervalued currencies in the EM universe.  This view is hard to square with an expanding current account deficit, but we shall duly report it. Nevertheless, the future of the lira is dictated by “hot money” flows  which have reached $9 billion YTD. Turkish banks and corporates have sharply trimmed their net F/X borrowing abroad. Domestics have added $16 billion to their F/X deposits YTD, meaning that the financing of the current account is now heavily dependent on the continuation of these financial flows into asset markets.

Herein lays the dilemma of CBRT. One variable which determines these flows is obviously the risk appetite for EM assets, which –for instance—according to BofA Merrill Lynch’s widely cited report is here to stay for at least another year. On the other hand, these flows are also highly interest-rate dependent. In a scenario where Fed and ECB tighten, while CBRT begins to cut rates in 2018, the soundness of TL might come in jeopardy.

To cut or not to cut, that is  the question for CBRT.

 

  1. J. Okacha

 

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