Economists have more questions than answers after Turkey hikes rates

TD Securities is among financial institutions wondering whether an interest rate hike by Turkey’s central bank actually means a real increase in borrowing costs.

Turkey’s central bank raised the benchmark interest rate by 2 percentage points to 10.25 percent in a decision on Thursday that surprised many investors. Economists at TD Securities had predicted a rate hike of 75 basis points while many others had forecast no change.

Investors in Turkey are hoping that the central bank’s tightening move is just the beginning as they look to monetary policymakers to arrest a slump in the lira’s value and deal with inflation, which is running at 11.8 percent, still well above the benchmark interest rate. Foreign investment has flooded out of the economy this year on concerns monetary and economic policy is too lax.

The benchmark interest rate - the one-week repo rate - sits at the bottom of the central bank’s so-called interest rate corridor, which now stretches to 13.25 percent. The bank can pick and choose at which rate to lend. On Friday, it elected to fund banks at the one-week repo rate. The weighted average cost of funding (WACF) for the institutions had stood at about 10.6 percent before Thursday’s decision.

“What will happen to central bank funding in the coming days?” TD Securities said, according to currency news and analysis website FX Street. “If the central bank decides to revert all funding activity to the repo rate, which now stands at 10.25 percent, so below yesterday's WACF at 10.65 percent, the central will have eased by 40 basis points, not tightened by 200 basis points.

“Will the central bank decide instead to recalibrate its facilities so that the new WACF will end up at around 10.65 percent as is now? If so, today's decision would be tantamount to a hold.”

TD Securities said the direction of the lira will now depend on the consequences of the rates decision, rather than the decision itself. Economists have called on the bank to simplify monetary policy by lending at one, benchmark rate of interest, in order to make monetary policy more predictable.

“The problem with using unorthodox measures, as the central bank is doing right now, is that not everything appears clear as it should,” the firm said. “So, for instance, has the central bank really shifted the whole corridor up by 200 basis points? We have seen no official communication of this so far, even though it is a logical and sensible thing to do.”

The lira reversed gains it made on Friday morning, trading almost flat at 7.62 per dollar. It had hit a record low of 7.72 per dollar before the rates decision, then traded as high as 7.496 earlier on Friday.

“Will the central bank provide funding at the same conditions as yesterday, in which case the WACF will shoot up to 12.65 percent in just a few days? Well, in this case, we will be talking of real tightening,” TD Securities said.