News & analysis

At mid-day today, the Turkish central bank (TCMB) cut interest rates by 50bps from 8.75%, which fell in line with our expectations and the market’s median projection.

The bank acknowledged that core inflation may be higher in the short-run due to the increasing prices of food, but on net falling inflation and economic activity allowed space for the ninth consecutive rate reduction. The SARB, in a similar predicament due to the impact of Covid-19, also lowered rates in line with our expectations. The South African repo rate now sits at a record low of 3.75% after the monetary policy committee voted 3 to 2 in favour of a 50bps reduction as opposed to 25bps.

 

TCMB SEES ROOM IN INFLATION PROJECTION TO CONTINUE LOWERING RATES

While the Turkish central bank acknowledged rising inflation pressures in certain goods, overall it saw enough comfort in the disinflationary effects coming from flailing demand conditions to continue cutting rates. The projection that sluggish demand conditions would dampen inflation in 2020H2 sees a marked shift from the last monetary policy announcement where the downside risks to the bank’s inflation outlook were skewed to the end of the year. The bank has revised down its inflation forecasts from 8.2% YoY to 7.4% since, which would see rates return to positive real territory in the latter part of the year.

For now, inflation remains at 10.94%, but along with reduced consumer demand stemming from the pandemic, low oil prices and high base effects are also likely to suppress inflation.

Upside inflationary pressures coming from the recent slide in the lira past the 7.00 mark are likely to filter through in the coming periods, but with USDTRY dipping below the psychological level once again the pass-through may be more muted. This was referenced in Bank’s statement, where they reiterated that lower commodity prices affect the inflation outlook favourably despite the recent TRY depreciation. Risks to the TCMB’s inflation outlook are plentiful, especially with the central bank’s bond-buying scheme, but under the current projections further monetary tightening is likely.

For the lira, this doesn’t necessarily mean too much. Nominal yields remain high, despite real yields being one of the lowest globally, but foreign investor sentiment was all but destroyed in measures taken recently to protect the lira. Authorities use of reserves and liquidity measures saw investor confidence take another hit. While measures were taken to dry up offshore liquidity to defend the 7.00 level from speculative trading as official reserves dried up, another spike in offshore short funding rates has deterred most investors from purchasing Turkish assets. Central bank data and Bloomberg estimates show that foreign investors made up just under a third of all lira trades in the 30-days until May 12th, down from highs of 68% in 2018.

This is the lowest level of foreign activity in decades, highlighting how authorities measures crippled offshore sentiment and participation. Meanwhile, trades between Turkish lenders made up 37% of the market, the most on record.

With the inflationary channel allowing, we expect the TCMB to continue lowering nominal rates by up to 50bps into the second half of the year, while the capital controls will remain for some time – likely until the global environment becomes more favourable. We don’t expect the 7.00 level to be breached again in the interim, with offshore liquidity likely to remain thin as officials scramble to secure swap lines with other central banks to bolster reserves.

 

Inflation base effects favour disinflation channel, while offshore measures drive TRY below 7.00

 

SARB ALSO CUTS RATES BY 50BPS, BUT TO FILL THE FISCAL SHORTFALL AS GDP FORECAST DOWNGRADED

This afternoon the SARB followed in the TCMB’s footsteps, cutting rates by 50bps to a record low of 3.75%, as continuing lockdown measures erode inflation and expand the output gap.  The central bank now expects GDP to contract by 7.0% (6.1% previously) but raised its 2021 forecast from 2.2% to 3.8% and its 2022 forecast from 2.7% to 2.9%. Inflation is now expected to average 3.4% in 2020, down from 3.6% previous, but the level of certainty around this forecast has dramatically increased. While the USDZAR rate on which the forecast was made was revised up from 17.80 to 18.40, the passthrough is expected to be around 0.1% and has been more than offset by the collapse in energy prices – assumed price of oil was revised down from $42 to $37.

The inflation outlook continues to see downside risks, notably from a wider output gap, weaker exchange rate pass-through and lower food prices. Goldman Sachs forecasts estimate that the negative output gap will suppress demand-side price pressures, leading to a more sanguine medium-term inflation outlook. With this in mind, it is likely that the SARB will continue in its cutting cycle. With very limited fiscal stimulus coming from new spending as opposed to redirected spending, it is our view that the central bank will have to continue filling the shortfall.

While the government are expected to announce a supplementary budget in June, the lack of fiscal space and conservative stimulus package initially doesn’t suggest a large fiscal windfall will derail this outlook.

The SARB has already outlined in its prior forecasts that 100bps of cuts are pencilled into their projected path this year. In this light, we expect 2 further cuts in 2020H2 of 25bps a piece, befitting with the conservative approach central banks are now taking as they await further information and economic data.

 

ZAR rallies 1.5% on SARB rate cut as more stimulus comes to rescue the South African economy. The rand’s rally is notable as broadly the US dollar trades on the front foot in today’s session

Today’s rally in the rand from further growth stimulus highlights the limited repercussions of rate cuts from currency markets.

Should that channel of inflation pass-through remain muted, it may embolden the SARB to cut rates more aggressively than in our base case, or potentially even front-load them in another early 50bps cut. With a pick-up in risk sentiment and foreign investors returning to the SAGB market, we maintain a bullish stance on ZAR in the short-term, however, our confidence in this forecast is lower than usual given the fluid situation the global economy currently experiences.

 

EM rate cuts year-to-date

 

Author: Simon Harvey, FX Market Analyst

 

 

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