The Turkish Central Bank raised its main interest rate from 8.5% to 15% today, as new governor Hafize Gaye Erkan attempts to guide Turkey towards more orthodox monetary policies.
Since the reelection of Recep Tayyip Erdogan last month, traders have been optimistic that the Turkish President is prepared to chance course on his unconventional beliefs that have helped fuel an economic crisis in the country. Erdogan first appointed former Merrill Lynch economist Mehmet Simsek as his finance minister, before also appointing former Goldman Sachs banker Erkan as central bank governor.
These two market-friendly figures – who subscribe to the orthodox belief that the route to lowering inflation is hiking interest rates – helped raise hopes that Ankara could change course decisively.
However, with most global investment banks predicting that Erkan would hike rates to at least 20%, her more cautious approach has raised concerns that Turkey is not yet back on the path of economic orthodoxy.
Timothy Ash, an emerging markets economist, told Disruption Banking that the 6.5% hike was “very disappointing.”
“It’s not enough. The market was expecting at least 20%. The lira will be vulnerable,” he added.
The lira has indeed posted losses against the US Dollar in the aftermath of the announcement, with the greenback up almost 4% against the Turkish currency since the start of the day alone. Yields on five year credit default swap market, the best gauge of perceived risk in Turkish markets, are also up. Further declines could be in store for both these financial assets depending on the central bank’s next moves.
Simsek sought to assuage traders’ concerns by arguing that the bank’s foreign exchange policies are being designed in such a way as to attract capital inflows. Ash told Disruption Banking that “this suggests lira devaluation rather than higher rates will do the heavy lifting in terms of current account adjustment.”
This indicates that foreign exchange traders should brace themselves for a significantly weaker Turkish lira in the months to come. Whether this strategy will be successful in lowering rampant inflation and a chronic balance of payments deficit in Turkey remains to be seen.
Author: Harry Clynch
