The Turkish central bank has been through a tumultuous two-year period. Three governors, two different styles of monetary policy systems, and two waves of significant lira depreciation have led to one thing: monetary policy returning back to the basics. The first interest rate announcement by Governor Agbal has seen the CBRT revert to the 2018 playbook.
That is, resetting the interest rate corridor and emphasising transparency in the monetary policy framework with the one-week repo rate returning as the key policy rate for markets to watch. This is of stark contrast to the system implemented under his predecessor Governor Uysal, who managed liquidity conditions in the interbank market to force rates higher. By hiking rates by 475bps to 15%, the CBRT hasn’t only raised the average cost of lending by 20bps, but has made it very clear to markets that the effective 2018 regime will be rolled out again. In the press statement, the central bank was very clear in forcing this message, reiterating it twice in the forms of; 1) “the Committee has decided to provide all funding through the main policy rate, which is the one-week repo auction rate”, and 2) “the Committee has decided to implement a transparent and strong monetary tightening”. This bodes well for the lira, which took the news positively and reversed early losses to rally over a percentage point post-announcement.
Coming into the event, the risks were there that the market was priming itself for disappointment.
The recent lira rally below the 8.00 handle caused by the changing of the guard at the CBRT and Finance Ministry, along with conducive comments for higher rates in the short-run by President Erdogan, would prove to be fickle if the CBRT didn’t meet expectations today. However, the CBRTs decision did exactly that – meet expectations. The decision not only brought real rates back into positive territory, but increased the credibility of the monetary framework by reinstating transparency – the latter wasn’t widely expected. By doing so, the lira turned from sustaining losses to rallying over a percentage point against the dollar and euro. The currency is now doing much of the CBRT’s dirty work in controlling the inflationary channel as domestic inflationary pressures were already beginning to normalise, suggesting this hiking cycle will reach a lower terminal rate compared to 2018 and will be front-loaded.
Governor Agbal isn’t out of the woods just yet, however. If he is to truly follow Governor Cetinkaya’s playbook of 2018, the problem wasn’t necessarily higher interest rates to control double-digit inflation. Centinkaya’s downfall was ultimately not lowering rates rapidly enough to appease political pressure in an attempt to solidify the deflationary channel further. While President Erdogan is on board with higher interest rates in the interim, in order to control inflation and strengthen the lira, the questions remain whether the institutional barriers remain.
As these questions remain, the CBRT will need to continue hiking rates, albeit at a slower pace than today’s and that seen in 2018, in order to buy back credibility from the market.
As the hiking cycle continues and approaches the terminal rate, where inflationary pressures subdue and the deflationary channel forms, the credibility and independence of the CBRT will be examined again by markets.
Forget the corridor, it is all about the one-week repo rate again
Lira traders look upon the CBRT decision favourably
Author: Simon Harvey, FX Market Analyst