Weak Lira Puts Rate Hike Back on Turkey’s Radar Days Before Vote

Beril Akman
·4 min read

(Bloomberg) -- An interest-rate hike is back on the table in Turkey just two months after the central bank declared its tightening cycle over.

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Revived demand for hard currency ahead of local elections on March 31 is speeding up a depreciation in the lira and contributing to a decline in foreign reserves, just as the outlook for inflation turns for the worse. What’s not clear is if Fatih Karahan, who telegraphed a hawkish message at his first meeting as governor a month ago, sees a compelling case for a rate hike already.

Given a slew of backdoor tightening measures in recent weeks, the most probable scenario for a majority of economists is still that the Monetary Policy Committee keeps its key rate at 45% on Thursday. Economists at Deutsche Bank AG and Goldman Sachs Group Inc. are the lone dissenters predicting an increase, according to a Bloomberg poll.

While the timing of a possible rate hike is in dispute, some of the world’s biggest banks consider it a question of when, not if. Morgan Stanley is among those expecting an increase in April.

A 500 basis-point hike “could be the ultimate hawkish signal to markets to deliver in case of ongoing deviation from inflation forecasts,” Deutsche Bank analysts including Yigit Onay said in a note.

Read more: Turkey Finance Chief Highlights Central Bank Policy Independence

The Turkish lira is the worst performer among emerging-market currencies tracked by Bloomberg this month, with a loss of about 3.6% against the dollar. It’s down almost 9% in the year to date. As local elections approach, the bigger worry is a repeat of its slump after last year’s presidential vote, when it dropped as much as 7% in a single day.

What Bloomberg Economics Says...

“After the sharp currency slide seen in early March, we recognize the risk of a further rate hike at Thursday’s meeting has increased. Even so, we think this movement is related to heightened uncertainties in the lead-up to local elections on March 31. As such, we maintain our position that a further policy rate increase is a more probable risk scenario after the vote.”

— Selva Bahar Baziki, economist. Click here to read more.

The final stretch before Turkish elections is an unusual time for officials to contemplate tighter policy. At stake in the polls are mayoral seats in the country’s biggest cities, a chance for President Recep Tayyip Erdogan’s ruling party to take back control of Istanbul and Ankara from the opposition.

In years past, an economic remedy favored by Erdogan has been to try to buy off the electorate with ultra-low rates and fiscal giveaways. The course has partly shifted since last year’s presidential ballot, when critics warned Turkey was at risk of a balance-of-payments crisis.

A more mainstream approach since then has produced eight straight rate hikes, enough to pique the interest of global investors. But a surprise upswing in consumer prices last month returned the spotlight to inflation that’s on track to exceed 70%.

Read more: Turkish Rate Hike Drumbeat Gets Louder as Inflation Heads to 70%

A survey of market participants by the central bank showed their year-end inflation outlook rose by more than a percentage point to over 44.2% this month, far higher than currently forecast by policymakers. Monthly price growth — a gauge closely watched by the monetary authority — accelerated to 4.5% in February.

“The purpose of the hike will mostly be to signal that the bank will and can hike if needed in line with its own guidance” to avoid the perception that its recent measures mark “a return towards a less orthodox policy framework,” said Goldman analysts led by Kevin Daly.

The central bank has so far taken a different tack to support the exchange rate, selling lira-settled foreign-currency forwards and imposing restrictions on loan growth.

An outright rate increase would instead create incentives for savers to keep money in lira assets and may pave the way for a return of foreign capital, according to Deutsche Bank. Inflows have been slow and foreigners exited Turkish assets in the first two weeks of this month.

Gordon Bowers, a London-based analyst at Columbia Threadneedle Investments, said that while a rate hike isn’t expected, such a move would be a “huge positive shock to investor confidence.”

It would show “the central bank has autonomy, price stability is being prioritized, and authorities have a stronger tolerance for weaker growth than we’ve seen in the past,” he said.

--With assistance from Tugce Ozsoy and Joel Rinneby.

(Updates with lira performance in sixth paragraph.)

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