Turkey's central bank signals for rate hike after lira slide

ISTANBUL - Reuters

The central bank intervened heavily to stabilize a sharply plunging lira last week, but it could not achieve it’s desired end. AFP photo

Turkey’s central bank signalled yesterday that it is set to raise interest rates to stabilize a plunging lira, after intervening heavily last week to shore up the currency as it sank to record lows.

In a rare written statement ahead of a monetary policy committee meeting, Governor Erdem Başçı said global policy uncertainty and volatility would not be allowed to damage financial and price stability in Turkey.

“A measured step to widen the interest rate corridor will be on the agenda of the next monetary policy committee meeting,” Başçı said in the statement ahead of the July 23 meeting.

That suggests the bank is ready to try to stabilize the market by raising its overnight lending rate, the upper end of the ‘corridor’ or gap between the rates at which it lends and borrows money to keep markets and the currency steady.

Emerging markets like Turkey have been hit hard since early May, when the U.S. Federal Reserve signalled it may begin withdrawing its stimulus, the first hint of a U-turn in the easy policy the world’s major central bank have implemented since the financial crisis.

Last month’s anti-government protests across Turkey added to pressure on the lira.

The central bank appears to be ready to take action to support the currency, even though Prime Minister Tayyip Erdoğan will be reluctant to see a rate hike that slows economic growth.

The currency firmed to 1.9390 to the dollar by 0823 GMT from 1.9450 before the bank’s statement. The yield on 10-year government bonds fell, as did the cost of insuring Turkish debt, with five-year credit default swaps down 11 basis points from Friday to 208 bps, according to Markit.

“The CBRT (central bank) bows to the inevitable ... clearly indicating that it will hike the top end of the rates corridor,” said Timothy Ash, head of emerging markets research at Standard Bank.

Burning up reserves

Raising the lending rate would effectively increase the real interest rate on lira assets, making them more attractive to foreign investors.

The central bank had stepped up its foreign currency auction sales since June 11 in a bid to underpin the currency, and has now sold $6.3 billion this year. But analysts have pointed out that this only runs down the country’s net reserves, which bankers calculate have fallen below $40 billion.

“The CBRT is acknowledging by these actions that its prior strategy of using FX reserves to defend the lira simply was not working, and risked just blowing scarce reserves away,” said Ash.

Bankers say the central bank may have to raise the upper end of the rate corridor by at least 100 basis points to stop the currency slide.

The central bank’s overnight lending rate is currently at 6.5 percent, its one-week repo policy rate at 4.5 percent and its overnight borrowing rate, the lower end of the corridor, at 3.5 percent.

Erdoğan said yesterday the central bank and other institutions were acting “with determination” in response to market volatility and the hints of a tighter Fed policy.

The central bank has been reluctant to hike rates following a credit-fuelled boom, while Erdoğan, aware of the negative impact on Turks of higher borrowing costs, has blamed a “high interest rate lobby” for instigating anti-government protests.

“Higher policy rates will inevitably mean lower growth, and it will be interesting to hear the reaction from policy hawks in the government,” Ash said.