Turkish Central Bank: Bold Move or Hail Mary Pass

January 28, 2014

The rift between the government of Prime Minister Ergodan and the central bank just got a lot wider.  Ergodan could not have been more heavy-handed in pressuring the central bank not to hike interest rates, which it did not do at this month’s scheduled meeting on January 21.  That inaction and a deepening government scandal had greatly intensified the lira’s plunge to 2.39 by January 27.  The exchange rate’s slide had augmented higher food prices to keep inflation far above the central bank’s target of 5%.  After an emergency late-night monetary policy meeting, the Central Bank of Turkey

  • Announced increases in the one-week repo rate of 550 basis points to 10.0%, in the overnight lending rate of 425 bps to 12.0%, and in the overnight borrowing rate of 450 bps to 8.0%. 
  • Released a statement asserting “the Central Bank liquidity will be provided primarily from one-week repo rate instead of the marginal funding rate in the forthcoming period,” promising “tighter monetary policy stance will be sustained until there is a significant improvement in the inflation outlook,” and setting a goal of reducing inflation, now at 7.4%, to 5% by the middle of 2015.
  • Published an open letter to Ergodan in accordance with a prior agreement to write such a statement should inflation deviate from target by more than two percentage points explaining why such happened and what the central bank intends to do to correct the deviation.  Although going by the book, the letter and very large rate increases, exceeding all expectations, are a provocative act containing significant risks.

My initial though after learning of the size of the interest rate hikes was Britain’s Black Wednesday, when market pressure led by the hedge fund of George Soros knocked sterling out of Europe’s Exchange Rate Mechanism (ERM).  Before the British government capitulated at the end of September 16, 1992, it had raised the key Bank of England interest rate in two stages from 10% to 12% initially and a while later on the same day to 15%.  Those increases were two Hail Mary passes that both fell incomplete.  But in Turkey’s instance, the market has acquiesced so far, and the lira rebounded to about 10% above Monday’s low.

Whether the lira will remain stable remains very much in doubt.  The economy is already very weak and laden with a current account, political instability, and a global environment that’s very hostile to several emerging market currencies including the lira.  The mood could change Wednesday when the Fed is likely to endorse another tapering of its quantitative stimulus.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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