Justifying tomorrow’s rate cut

Judging by the expectations of economists surveyed by business channel CNBC-e, rate cuts are a given at the Central Bank of Turkey’s Monetary Policy Committee (MPC) rate-setting meeting on Feb. 24.

Eighteen of the 24 analysts polled believe that the Bank will lower its policy (one-week repo) rate of 7.75 percent tomorrow, with expectations equally divided between a 0.25 and 0.50 percentage points cut. Of these, almost all expect it to also lower its borrowing rate of 7.50 percent, the floor of its interest rate corridor, by the same amount.

The floor of the corridor is not really used, so a cut in that rate, which would need to be lower than the policy rate, would be a technical move. Even the policy rate may not matter as much if the Bank chooses not to lend too much at the one-week repo, opting for the overnight lending rate at 11.25 percent, which is the ceiling of the corridor, instead.



In fact, the Central Bank has cut the policy rate in the past to silence President Recep Tayyip Erdoğan and his inner circle, while not really loosening its stance. However, Erdoğan seems to have finally noticed: In his latest attacks on the Bank, he specifically asked for lower overnight lending rates.

Accordingly, about half of the economists foresee a reduction of 0.25 to 0.75 percentage points in this rate as well.

But recent economic and financial developments hardly warrant rate cuts. For one thing, inflation fell less than expected in January, and it may even rise in February because of higher food prices.
Monetary policy should not depend on a couple of months of data but on longer-term trends. However, core inflation has remained high as well. Besides, it was Gov. Erdem Başçı who had promised an emergency rate cut on annual inflation falling more than one percentage point in January, tying monetary policy to monthly price developments.



The Central Bank’s own guideline of keeping the yield curve, which it defines as the difference between policy and five-year government bond rates, flat cannot justify rate cuts, either. With the recent rise in the latter, the two rates are virtually the same at the moment. Incidentally, markets are not pricing lower rates: While government bonds are not pricing any cuts, the forward swap market is actually pricing a 0.25 percentage points rate hike in the next three months.

You could argue that the lira has recently stabilized. Its volatility has indeed fallen, and it has pulled back after hitting an all-time low of 2.50 against the dollar, but the lira-dollar exchange rate is still 5 percent lower than its level after last month’s rate-setting meeting.



You could also maintain that, with the resolution of the Greek drama (for now) and the Fed’s latest minutes, which were (wrongly, IMHO) perceived to be dovish, the global environment supports rate cuts. But it would be too imprudent to act right before Fed chair Janet Yellen’s semi-annual testimony before Congress on Feb. 24-25, which she may use to correct the recent dovish perceptions and cause some market turbulence.

Maybe, Başçı and his buddies at the MPC will show that they really have “cojones” and skip the cuts for this month. If not, I’ll be really curious to read how they justify them this time around.