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Turkey’s currency and bonds took a hit on Thursday after the central bank failed to deliver on what many investors believed was a widely signalled intention to raise interest rates aggressively to bring inflation and the currency under control.
The lira fell to more than TL3.87 against the dollar, from TL3.81 at Wednesday’s close, while the yield on the 10-year government bond rose 13 basis points to 11.96 per cent after the central bank raised its policy rate by 50bp to 12.75 per cent.
This was half the 100bp expected by most analysts and kept the real rate in negative territory against inflation of 12.98 per cent in the year to November, a 14-year high and far above the government’s 5 per cent target.
“Is that a joke?” asked Timothy Ash of BlueBay Asset Management in a note to clients after the bank’s decision. “The [central bank] never seems to learn.”
Bonds and the currency recently pulled back from multiyear lows in November after Recep Tayyip Erdogan, Turkey’s president, reined in his notorious invective against an ill-defined “interest rate lobby” and senior government figures signalled that the central bank had full freedom to act.
Hatice Karahan, the president’s chief economic adviser, told the Financial Times this week that Mr Erdogan was “concerned about inflation and wants it to be reduced as quickly as possible”.
She added: “The main thing to underline is that the central bank has full independence and the firm determination to reduce inflation to the target.”
Mr Erdogan’s unorthodox contention that high interest rates cause inflation while damping growth were at least partially rebutted when Turkey posted gross domestic product growth of 11.1 per cent in the third quarter earlier this week. That number raised expectations that the central bank would feel emboldened to raise rates on the back of robust growth.
While 100bp was the consensus expectation, many analysts argued before Thursday’s decision that 300bp to 400bp would be needed to reassure markets that the central bank was in the driving seat.
Piotr Matys, EM strategist at Rabobank, said the fear was that a modest rate rise would reignite selling pressure on the lira “and unfortunately the central bank left the market disappointed”.
Yet the pressure on the central bank to act has eased in recent weeks. The dollar’s comparative weakness since early November has reduced pressure on the lira, while a high-profile court case in New York involving a senior Turkish banker has been less damaging than expected.
Furthermore, despite efforts by the more economically orthodox figures in government to reassure markets, analysts say there is little appetite among the population for firm action against inflation.
“I’m not sure people care that much,” said Inan Demir of Nomura. “Growth is strong and the labour market is reasonably strong, so people in general are not complaining about the economic outcomes.”
While real interest rates remain negative, notes Simon Quijano-Evans of Legal and General Investment Management, when compared with forecast inflation next year of 9 per cent, the policy rate is strongly positive, at about 3.75 per cent.
“Along with Brazil and Russia, Turkey has the highest forward-looking rates in the world,” he says.
The problem, he adds, is that in Turkey, unlike Brazil and Russia, inflation is rising. “And it is not only rising, it is missing expectations and rising by more than anybody had expected, in the private sector or in the central bank,” he says.
He adds: “It’s a credibility issue. People really want to hear that the [central bank] is back in charge of monetary policy.”
Additional reporting by Roger Blitz in London and Mehul Srivastava in Istanbul