Turkish Central Bank signals more rate cuts, upbeat on economy

ANKARA - Reuters

Financial markets are pricing in a reduction of 50 basis points (bps) over the next three months, Erdem Başçı has said. AA Photo

Turkey’s Central Bank has signaled that it will continue “measured” reductions in interest rates, while preserving its year-end inflation forecast at 7.6 percent, pumping an optimism boost to markets and raising the demand for stocks.

The Bank has trimmed its main interest rate by 175 basis points since May despite stubborn inflation, although it has so far resisted the even deeper cuts called for by Prime Minister Tayyip Erdoğan as he gears up for a presidential election.

Announcing the Bank’s quarterly inflation report, Governor Erdem Başçı, who has repeatedly said any rate cuts will be moderate, said financial markets were pricing in a reduction of 50 basis points (bps) over the next three months.

“It doesn’t mean we are definitely going to do it, but a 50 basis point rate cut can be classified as moderate,” he told a news conference in Ankara.

“We may go a bit further than that. We can call 25 bps, 50 bps, 75 bps moderate, in line with our previous statements.”

The bank left its mid-point forecast for 2014 year-end inflation at 7.6 percent, unchanged from three months ago, but still well above its 5 percent target. It left its 2015 year-end inflation mid-point forecast at 5.0 percent.

Turkish bonds and shares, led by banks, strengthened.

The benchmark 10-year government bond yield fell to 8.69 percent, its lowest since last October, compared with 8.82 percent before the news conference.

The main Istanbul share index, which was 0.5 percent higher when Başçı began speaking, was up 1.1 percent at 83,756 points. The banking index climbed 1.6 percent.

“This sounds like a dovish Başçı ... this seems like getting ready for more cuts this year [which] will dovetail with the political calendar,” said Timothy Ash, head of emerging markets research at Standard Bank in London.

Last week, the Central Bank trimmed its main interest rate for a third consecutive month, cutting its main one-week repo rate by 50 basis points to 8.25 percent.

Erdoğan has repeatedly called for a sharper move, hungry for growth ahead of the Aug. 10 presidential election in which he is the front runner, as well as parliamentary polls next year.

Başçı said monetary policy nonetheless remained tight and this stance would continue, enabling the bank to keep inflation expectations under control.

Positive outlook

Başçı said economic activity would continue to strengthen in the second half, with domestic demand supporting falls in inflation, and the current account deficit, Turkey’s main economic weakness, continuing to narrow to 5.5 to 6.0 percent of output by the end of the year.

He said the lira had stabilized, describing its current levels as “reasonable,” and said the impact of exchange rate volatility on inflation had started to taper off from the second quarter, although a recent drought was keeping food prices high despite a downward trend in core inflation indicators.

Against this background, Başçı said the bank may reduce the volume in its daily forex auctions to $10 million from a current $20 million.

The lira was trading at 2.0920, little changed from its level before the news conference.

There was positive news on July 24 on the tourism front, an important source of foreign exchange, with ministry data showing the number of foreign visitors to Turkey rose 6.4 percent year-on-year in June to 4.335 million people.

Separately, Başçı said the chaos in Iraq and Ukraine were significant risk factors, but the impact of such geopolitical risks on financial markets were generally temporary.