Today’s 100bp cut by the CBRT is a moment that was long-feared by investors as this signals that President Erdogan’s preference for low rates has now materialised. Going into the event, the broad market consensus was for rates to be kept unchanged, especially given August’s two-year high in inflation of 19.25%, which was just above the central bank’s interest rate of 19% at the time. The ongoing inflationary rises built up pressure for tight monetary policy, which makes today’s decision a concern for markets as it signals that Governor Kavgioglu is no longer in control of the decision-making process at the CBRT. If history is any guide, Kavgioglu may have been threatened with dismissal if rates would have remained on hold, which is the explanation for the against market consensus 100bp rate cut.
In the rate statement, the CBRT explains the recent rise in inflation has been driven by supply side factors such as the rise in food and import prices, increase in administered prices, and increased demand due to reopening.
This signals that the central bank assesses these effects are due to transitory factors, but the market reaction to the event shows traders think otherwise.
Turkey has experienced substantially higher inflation than other emerging markets over the last years, as prices have been held up by TRY depreciation, depleted monetary credibility and now also a burst of demand as the economy reopens. The CBRT expects economic activity to remain strong in Q3, and uses this as a reason to justify the 100bp rate cut.
Today’s decision is a large concern for the CBRT’s credibility, and the lira’s price action is telling of this.
The currency tumbled to record lows against the US dollar while keeping just under the 9.00 handle, although the pair looks vulnerable with the 9 level being the next breakthrough in the coming weeks. This becomes especially relevant when inflation continues to print higher in September, while negative real rates are a realistic prospect for the medium-term as well if the TRY depreciation filters through to inflation and the Turkish economy’s structural price growth in turn snowballs into an even weaker lira.
Traders panic sell the lira after CBRT’s decision weighs on credibility and autonomy
Author: Ima Sammani, FX Market Analyst
Sammani was quoted by Reuters on the CBRT decision, read here.