Steep rate cuts would stir dollar rush: Turkish Central Bank governor

KASTAMONU - Reuters

Central Bank Governor Erdem Başçı defended the Bank’s monetary policy and shared its view on key indicators, delivering a presentation at the Kastamonu Chamber of Commerce and Industry. AA Photo

Turkey’s Central Bank governor has set out his case against the sharp cut in interest rates championed by some in government, saying it might prompt Turks to hoard dollars and that growth would in any case pick up towards the end of 2014.

Speaking at a conference in the Black Sea town of Kastamonu on Sept. 11, Central Bank Governor Erdem Başçı said too large a reduction in interest rates would stoke inflation, already running at the upper limit of the bank’s forecasts.

“If we were to cut interest rates very sharply, that would prompt citizens to turn from the lira to forex. Foreign investors would also likely act in a similar way. There would therefore be an unwanted upward impact on inflation,” he said.

Başçı noted the slowdown in growth in the second quarter but said it was expected to pick up again towards the fourth.

The Central Bank would keep monetary policy tight until there was a significant improvement in the inflation outlook, he said.

Data released on Sept. 10 showing the Turkish economy grew less than expected in the second quarter increased political pressure on the bank to cut rates further and helped send the lira to its lowest for more than five months.

‘No backward step’

The Central Bank hiked rates sharply in January to defend a tumbling lira, a move it has only gradually been unwinding.

It unexpectedly lowered its overnight lending rate at its last meeting on Aug. 27, a move seen as having little easing impact and intended more as a signal to the government that it is supporting the economy.

The bank had cut its main one-week repo rate by 175 basis points in the three months before that decision, fuelling criticism from some economists that it was caving in to political pressure despite persistently high inflation.

“The rate of loan growth started to come out just as we desired and due to that we were able to cut rates somewhat more. Inflows from abroad, though moderate, began and we were able to make such a cut,” Başçı told the conference.

“But one has to go carefully. When we take steps they should be solid steps. We have to advance in a way that does not require taking much of a backward step,” he said, echoing previous comments that any further rate cuts would be moderate.

The foreign exchange currency level has been decisive in the inflation rate over the past four months, but now food prices, which have been rising above the seasonal average due to drought, have adversely affected inflation, the governor said.

“Food inflation is above 14 percent and it will be hard for it drop below 9 percent by the year-end,” he stated.

“The risks regarding the targeted 7.6-percent inflation are upwards,” Babacan said, while ruling our concerns that inflation will be at double-digit levels at the end of year.

“We have plenty of ready-to-go policy tools in our hands, we can take all kinds of measures.”

Turkey’s consumer price index rose to 9.5 percent in August from 9.3 percent in July, realizing far from the Bank’s forecast of 7.6 percent for year-end, official data announced yesterday showed.

Başçı noted that the inflation was expected to decline after “temporary fluctuations” in food prices lose their affect, seeking to sooth concerns over price changes in the market.

The Central Bank’s critics say that stance does not send a strong enough signal on the will to fight inflation and serves only to confuse financial markets.

The ruling Justice and Development Party (AKP) is keen to maintain its strong record on growth in the run-up to a parliamentary election next June but faces growing headwinds, with the economy slowing more than expected in the second quarter and inflation stubbornly high.

President Tayyip Erdoğan, prime minister until last month, has urged sharper rate cuts to spur growth, and Economy Minister Nihat Zeybekci has followed his cue, saying on Thursday that Turkey was “compelled” to grow at least five percent a year.

The tug-of-war over Turkey’s economic management has raised concern about divisions within the Cabinet, the independence of the central bank, and policy predictability.