After depleting its reserves, the Turkish central bank reverted back to hiking rates behind closed doors in order to raise domestic interest rates and stabilise the lira at around the 7.3-7.4 level. This has followed the playbook of previous hiking cycles in the midst of TRY depreciation, but it is merely a short-term fix. The reasoning behind Governor Uysal decision is relatively clear cut.
Not only are higher rates politically sensitive, but the drivers behind the latest bout of TRY weakness are more transitory.
The beginnings of the global economic recovery in conjunction with the scaling back of credit stimulus via the asset-ratio rule should begin to ease the pressure on the lira, meaning the aim of the game for the TCMB is to hold out from anything too dramatic until the tailwinds for the lira’s recovery take effect. However, there are more structural vulnerabilities in play. Foreign investment has been obliterated by the lack of transparency over Turkey’s monetary policy framework. Recurring liquidity shortages have left offshore markets in tatters, drying up access to USD liquidity further in Turkey and reversing any gains made in the wake of 2018 towards a clearer monetary structure. Additionally, rising inflation from the lira’s depreciation risks undermining the growth at all costs objective undertaken by President Erdogan and will keep real rates in negative territory for some time.
Should the tailwinds to the lira’s recovery not arrive anytime soon, or another economic shock occurs prior to this event such as a more aggressive second-wave in Europe, Governor Uysal’s decision to hold rates at today’s meeting may come back to bite him.
By opting to use fringe tools such as liquidity measures to guide rates higher, the TCMB leaves little room for manoeuvre should conditions deteriorate further. They could continue to use liquidity measures to drive interbank markets into the late liquidity window, which commands an interest rate of 11.25%, while also conducting longer-dated repo auctions which will inevitably yield a higher average interest rate out of necessity. But there is little room to go further. The drawbacks of such a playbook have been realised in crises of past times and it seems as if authorities haven’t learnt the lessons of the lira crisis in 2018. Should further liquidity measures prove insufficient to the uncertain future environment, the TCMB will ultimately be forced to hike the whole monetary channel more aggressively than they would have today.
The average cost of Bank funding rises in Turkey as liquidity measures force markets into more costly interest rate windows.
Lira slides back towards record low as the central bank holds its policy rate at 8.25%
Author: Simon Harvey, FX Market Analyst