Central Bank of Turkey Raises Rates First Time in Two Years, By 650 bps to 15.0%, Lira Collapses

The Central Bank of Turkey hiked by 650bps to 15% for the 7-day repo rate at its June 2023 meeting, the consensus guess was 20%, with one call calling for to 40%. The lira touched a fresh record low, another 2.6% lower to 24.20 after. The move came after holding steady for a third straight month following a 50-bps cut previously in response to the country’s earthquake disaster. The lira tumbled to record lows again. We now have President Tayyip Erdogan is trying to retore policy credibility fresh from his re-election. Recall since September 2021 there had been concerted pressure from President Recep Tayyip Erdogan wanting rates cut to stimulate the economy, despite a collapsed Lira and soaring inflation. The market does not forget and play along with the Turkish mess.

TCMB

The TCMB prior to the earthquake had signaled it will end the rate-cutting cycle. Turkey’s currency, the lira remained soft near a record low, with one U.S. dollar buying 18.80 lira after the announcement. This is the first meeting since Erdogan won a third term in a runoff election May 28 and reappointed Mehmet Simsek to the helm of the economy. The former Merrill Lynch banker had previously served as Erdogan’s finance minister and as a deputy prime minister until 2018.

Erdogan also appointed Hafize Gaye Erkan this month as Turkey’s first female central bank governor. A former co-chief executive of the now-failed San Francisco-based First Republic Bank, Erkan replaced Sahap Kavcioglu, who oversaw a series of rate cuts.

The decision comes after 1050bps in unorthodox rate cuts since September of 2021 

Turkey Interest rates

Turks can’t afford bare necessities as inflation runs rampant from the collapsed currency.

On Tuesday, the government increased the minimum wage by 34%.

“We will take decisive steps in the fight against inflation,” Erdogan said yesterday. “We will increase our efforts to protect large sections of our people from the effects of inflation.”

Erdogan had fired three central bank governors who resisted pressure to cut interest rates before appointing Kavcioglu in 2021. Naci Agbal, who proceeded Kavcioglu, was removed from his post days after he raised rates.

Economists expect annual inflation, which declined to 43.7% in April from a peak of 85.5% last year, to rise again in the coming months, which the highest since 1998. The surging costs are largely due to surging costs of importing energy with an increasingly weak currency.  Independent economists at ENAG, a research group that studies inflation in Turkey, say the actual rate of inflation was likely more than 185% when it was 85.5%.

They also expected the central bank to keep rates on hold this month in line with Erdogan’s unorthodox policies that call for low rates. Kilicdaroglu’s opposition alliance has also pledged to reverse Erdogan’s program with aggressive rate hikes.

The latest current account and goods trade deficits have widened sharply, no surprise but contradicting Erdogan’s pledge that Turkey would consolidate a strong surplus position.

The yield on Turkey’s 10-year government bond rose above 12.0% in late March, the highest since November, as investors weighed on the Turkish central bank’s decision to hold its key interest rate unchanged at 8.5%. Bond yields had extended their rise since the beginning of the year amid abundant debt supply as the country increased borrowing to recover from the catastrophe and stimulate growth.

Benchmark bond prices were also pressured by investors’ preference for dollar-denominated debt in the country due to the lira’s weakness. On March 9th, Turkey raised $2.25 billion in dollar-denominated debt in its first bond deal on foreign markets since January, as the government started the country’s rebuild, estimated at $100 billion.

Restrictive measures have been introduced to support the bond market, along with others that were already in place. This included discouraging banks from holding inflation-linked bonds as collateral for funding from the central bank and the encouragement of lenders to buy longer-term government bonds. The central bank of Turkey when it broke its rate-cut pause and lowered the key interest rate by 50bps to 8.5% loosened financial conditions in response to the country’s earthquake disaster.

Turkey Government Bond 10y

Turkish authorities have been introducing rules that force banks to buy government bonds. In mid-October, a mandate was set for lenders with less than half of deposits in lira next year hold an additional seven percentage points of government bonds. This regulation alone created some TRY 88 billion in demand for government bonds, and it could double for those whose lira deposits are between 50-60% of the total deposits, according to bankers.

Lira Trampled Underfoot

The lira touched a fresh record low, another 2.6% lower to 24.20 against the dollar after Turkey’s central bank hiked its main one-week repo rate by 650 basis points to 15%, below the median estimate in a Bloomberg survey for an increase to 20%. The Turkish central bank has also spent tens of billions of dollars in foreign currency in interventions to prevent a more severe slide in the lira, economists say.

The central bank’s net forex reserves dropped to negative territory for the first time since 2002, standing at minus $151.3 million on May 19, in another sign of the pressure the economy faces due to the unorthodox policies.

The TCMB’s board has in the past signaled that it would continue to mandate measures to stimulate lira usage in Turkey until inflation falls to the 5% level

The Turkish government’s special savings program encourages people to keep their money in lira and introduced a rule that forces exporters to sell 40% of their foreign-currency revenue to the central bank.

Turkey is funding its unusual economic approach in part with an influx of money from Russia. Mr. Erdogan has deepened Turkey’s economic relationship with Russia this year and lately with Saudi Arabia. Turkey is boosting trade and allowing Moscow to turn to Turkey to ease the effect of Western sanctions. Erdogan turned to Russia to bolster the Turkish economy, accelerating trade between the two countries and welcoming inflows of Russian money that have helped Turkey shore up the foreign assets needed to stabilize the lira. To little affect as it heads towards USDTRY 20.

The currency is now worth about 40% of its value at the beginning of the year making imports at least doubly expensive. Turkey’s economy is heavily dependent upon imports for producing goods from basic foods to textiles, so the rise of the dollar against the lira has a direct impact on the price of consumer products.

Turkish Lira Collapse

Source: TCMB WSJ

From The TradersCommunity News Desk