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Emerging Europe Emerging Markets Research
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Turkey: We expect the CBRT to over-deliver again and to hike rates by 125bp next week
By Yarkin CebeciAC
Click here for the full Note and disclaimers
President Erdogan’s new cabinet will have to work hard to rebuild credibility and address the economy’s deep-rooted problems. Erdogan appointed his son-in-law and former energy minister Berat Albayrak as the new treasury and finance minister, leaving less controversial figures who have implemented macroeconomic policies over the last five to 10 years out of the cabinet. Given the grave erosion of investor appetite and the vulnerabilities of the Turkish economy, the new management team does not have much time. Investors will need to see a coherent and comprehensive program to deal with Turkey’s acute and chronic problems before changing their views on the country. Although the initial comments coming from Minister Albayrak underlined the need for prudent policies and were encouraging, foreign investors are nervous and undecided and await the new government’s policy initiatives. The first real test will be the July 24 MPC decision. In particular, investors want to see if political pressure could discourage the CBRT from delivering the much needed monetary tightening.
In light of the sharp rise in price pressures and collapse in policy credibility, further monetary tightening is warranted, in our view. The hawkish tone evident in the CBRT’s inflation assessment note released two weeks ago has shown that the CBRT has acknowledged the need for further tightening. The markets have priced in a 75bp hike and we think that—as it did in its last three moves—the CBRT could over-deliver to rebuild credibility. Hence, we expect the CBRT to hike its key 1-week repo rate by 125bp to 19.0%. We do not expect a major change in the interest rate announcement. In particular, the CBRT is likely to highlight again its determination to tighten further if needed. The CBRT will also likely to keep the main policy guidance sentence unchanged and state that “Tight stance in monetary policy will be maintained decisively until inflation outlook displays a significant improvement.” These references should keep the door open to further hikes if needed.
Although the main consideration behind the rate hike decision should be to rebuild credibility, macro fundamentals also support the case for hikes. We note that the sharp jump in inflation (to 15.4% in June from 12.2% in May) clearly manifested a worsening in price dynamics. The 2.6%m/m increase in CPI in June was the highest monthly inflation in the last seven years. It was not only the magnitude of the rise but also how broad-based the price pressures were that showed the worsening in price dynamics. Importantly, the rise in ex-post inflation has been strengthening the inflation inertia. The 12-month-ahead inflation expectations have already moved up to 11.1% from 9.2% over the last four months (Figure 1) and despite the expected narrowing, the current account deficit remains above 6% of GDP. This leaves the lira vulnerable to shifts in global risk appetite. In this environment, we think that the CBRT will hike rates by a final 125bp next week. We then see it remaining on hold until inflation starts falling in May 2019.
Given that President Erdogan has consolidated his power in the new presidential system and given his widely known views on the need for lower rates, some market players are worried about the risk that the CBRT will under-deliver next week. There are even those who fear that the CBRT starts cutting rates. We think that a premature monetary easing would be suicidal and is out of question. There is, however, the risk that the CBRT remains on hold or delivers just a symbolic cut. In such a scenario, we expect the credibility erosion to continue and the pressure on the lira and hence on the CBRT to increase significantly.
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