Emerging Markets | FX | Monetary Policy & Inflation
With the lira under pressure expectations are mixed on whether the Turkish central bank will opt for a sixth consecutive interest rate cut on Wednesday. We expect no change from the current 11.25%.
Inflation Continues to Edge Back Up
Turkey’s Central Bank (CBRT) is once again at a crossroads. After 1275bps in rate cuts since July last year the lira is under pressure and the focus on the true level of reserves has intensified. State banks have conducted regular foreign exchange sales in recent weeks, yet the lira has weakened 2% in the last month. Total open FX positions of the state banks reached US$4.8bn for the week ending February 7, its highest for a long time, with US$2.8bn additional positions opened, according to BRSA data.
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With the lira under pressure expectations are mixed on whether the Turkish central bank will opt for a sixth consecutive interest rate cut on Wednesday. We expect no change from the current 11.25%.
Inflation Continues to Edge Back Up
Turkey’s Central Bank (CBRT) is once again at a crossroads. After 1275bps in rate cuts since July last year the lira is under pressure and the focus on the true level of reserves has intensified. State banks have conducted regular foreign exchange sales in recent weeks, yet the lira has weakened 2% in the last month. Total open FX positions of the state banks reached US$4.8bn for the week ending February 7, its highest for a long time, with US$2.8bn additional positions opened, according to BRSA data.
Inflation has now inched up for three consecutive months. January CPI increased 1.35% MoM, lifting annual CPI to 12.15% from 11.84% in December, while core inflation (Index B) increased to 10.9%. Rising cost pressures can also be seen in the shift up in domestic PPI to 8.4% YoY, and 5.2% for prices of intermediate goods – main inputs for production. Additionally, service prices, which are not particularly sensitive to exchange rates, remained elevated, posting a 12.2% increase, reinforcing the view that this group remains rigid due to backward indexation. Core indicators, closely monitored by the CBRT, also exhibited some upward movement.
We expect inflation to edge up further in February due to the base effect. The rise in the annual change in the currency basket to about 13.0%, along with the recent weakness in the exchange rate, signifies the incipient strengthening of a factor that has an upward impact on inflation. Hence, even assuming that the recent depreciation does not morph into a currency attack, it seems more probable for annual inflation to edge up further. We expect CPI around 12.5-13.0% in the first quarter, given the unfavorable base effect, and to gradually ease thereafter to end the year around 10.0-11.0%, and therefore above the CBRT’s year-end CPI estimate of 8.2%.
And Inflation Expectations Have Started to Follow
The earlier improvement in inflation expectations has now started to reverse. The CBRT’s February survey reported inflation expectations rising from 10.01% to 10.06% for year-end 2020; from 9.54% to 9.56% for the next 12 months; and from 8.51% to 8.52% for the next 24 months. Moreover, short- and long-term bond rates have topped 11% and the yield curve in the offshore swap market has shifting upwards.
Chart 1: 12 and 24-month Inflation Expectations Have Edged Higher
Source: CBRT
Consensus Split on Another Rate Cut – We Expect Rates on Hold
Given these negative signals expectations for the February 19 MPC meeting are mixed. Of the 19 economists participating in the survey, 7 anticipate no change, 7 expect a 50bps rate cut to 10.75%; 3 expect a 25bps cut to 11.00%; and 2 expect a 75bps cut to 10.50%. The median estimate of the survey points to a rate cut of 25 basis points. We expect no change in the policy rate.
Activity Has Rebounded
The current state of economic activity also suggests that support from monetary policy is not required to the extent it was before. IP growth jumped to 9.5% YoY in December; the manufacturing PMI increased to 51.3 and automotive sales jumped 90% annually in January, reflecting a marked acceleration in national income growth. While the trend growth in banking loan volume, the mainstay of this acceleration, has surpassed 25% as of the first week of February, the growth in consumer loans is even more pronounced. As such, the CBRT, in a bid to avert growth in the current deficit, may introduce new macroprudential measures.
The CBRT Could Use Inflation Forecasts to Justify Further Rate Cuts
The CBRT assessed the current trend in inflation as broadly consistent with its year-end forecast at its last MPC meeting on January 16 and in the accompanying Inflation Report. The 75bps cut was described as a “measured”, with the CBT maintaining its message “At this point, it is considered that the current monetary policy stance remains consistent with the targeted disinflation path”, signaling that it might gradually reflect improvements in inflation, inflation expectations and risk premium to the policy rate.
The CBRT may still decide for sustained interest rate cuts, on the grounds that 12- and 24-month forward-looking CPI estimates are lower than current inflation and that its own forecast is even lower. However, the fact that market pricing has shifted against it – unlike in earlier meetings – may well mean renewed difficulties in terms of credibility this time, in the event of a rate cut, and even more so in case it leaves the door open for additional cuts.
Haluk Bürümcekçi is the Founder & CEO of Bürümcekçi Research & Consulting, which specialises in the Turkish economy and the political landscape. Prior to this, Bürümcekçi was the Executive VP & Chief Economist at Burgan Securities, specialising in monetary policy and economic activity, and the Chief Economist at Fortis Bank, where he also covered market strategy.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)