Jul 25 2019

Turkey’s central bank cuts benchmark rate by 425 basis points to 19.75 percent

(Updated with economists' comments on rate cut)


The Monetary Policy Committee of Turkey’s central bank under the freshly appointed governor Murat Uysal announced that it had decided to reduce the policy rate (one-week repo auction rate) to 19.75 percent from 24 percent, citing a moderate recovery in economic activity.

The central bank had kept the benchmark lending rate on hold at 24 percent since September, when it hiked it by 625 basis points to prevent a full-blown financial crisis. The lira hit record lows last year due to rising inflation and spurred by U.S. limited sanctions over the detention of an American pastor.

Inflation in Turkey increased to a 15-year-high above 25 percent in October and fell to 15.72 percent year-on-year in June. The economy expanded 1.27 percent in the first quarter of 2019, after two quarters of negative growth. The lira has been the best performer of all currencies versus the U.S. dollar over the last six weeks, gaining about 8 percent, Bloomberg said on Wednesday.

The central bank said in a written statement published on its website that inflation outlook had continued to improve and was expected to be below the bank’s April projections by the end of the year.

“Accordingly, considering all the factors affecting inflation outlook, the committee decided to reduce the policy rate by 425 basis points,” it said.

The central bank's monetary committee said it saw maintaining a sustained disinflation process as key for achieving lower sovereign risk, lower long-term interest rates, and stronger economic recovery. 

“Keeping the disinflation process in track with the targeted path requires the continuation of a cautious monetary stance. In this respect, the extent of the monetary tightness will be determined by considering the indicators of the underlying inflation trend to ensure the continuation of the disinflation process,” it said.

Economists had predicted a rate cut but were uncertain about its size. Polls of economists conducted by Bloomberg and Reuters showed median forecasts of a 250-basis point rate cut, but the predictions ranged from 50 to 800 basis points. 

Timothy Ash of Bluebay Asset Management said on Twitter that he thought the central bank officials had wanted to break the 20-percent barrier. “If lira holds relatively well they will continue cutting aggressively in my view,” he said.

Economists saw the result of the July 25 meeting as an indicator of Turkey’s future political and economic direction. It was regarded as Uysal’s first test after the President Recep Tayyip Erdoğan removed the former governor Murat Çetinkaya for failing to obey the government’s request for rate cuts. Eventually, Uysal delivered the biggest interest-rate cut in at least 17 years, putting Erdoğan’s unconventional policy goals into practice less than three weeks after getting the job, Bloomberg said on Thursday.

“Murat Uysal was given a mandate to cut - or move aside for someone who would - and he cut to script. Challenge for him will be when he needs to hike. Has he got the gumption to tell the truth to power, The Power, when push comes to shove. And it will,” Ash said.

Economist Ümit Akçay said the bank had also changed the format of its traditional written statements, apart from the beginning and the ending. The revisions made in the format is an aftershock of Erdoğan's move to unexpectedly replace the central bank governor via decree, he said.

According to Akçay, it should also be noted that the bank cited predictions on the global economy in its statement, saying that weaker global economic activity and heightened downside risks to inflation had strengthened the possibility that the central banks of advanced economy would take expansionary monetary policy steps. The bank said those steps would likely surge demand for emerging market assets and risk appetite.

“In a way the continuation of global crisis became -for now- a saviour for Turkey,” Akçay said.

“The central bank is walking a tightrope between an interventionist president who wants lower rates and financial markets likely to penalise excessive easing,” economist Ziad Daoud told Bloomberg. “Easier global monetary policy will encourage the bank to continue cutting until markets turn against the currency.”

Zümrüt İmamoğlu, the chief economist of Turkey's leading business group TUSIAD, said on Twitter that it was not correct to call the rate cut the central bank’s decision, as in the new executive presidential system of Turkey, it became a decision made together with the political authority.

“It should better be called the decision of the administration,” she said. “It will continue.”

The hefty rate cut is based on three pillars, said economist and Ahval contributor Güldem Atabay. “Slowing global economic activity and the expected continuation of easy global monetary policy, along with still shrinking domestic demand in Turkey and of course the wishes of Erdoğan.”

Believing that disinflation will continue, the bank is likely to begin a process of fine-tuning from today and focus on minimising the extent of monetary tightness, she said.

Atabay expects the rate cuts will reach 800-900 basis points by the end of the year. However, the lira is prone to high volatility, due to the possibility of early elections and the risk of U.S. sanctions over Ankara's decision to purchase Russian S-400 missile systems, she said.

The expected impact of rate cuts on growth will be limited as long as Turkish economy’s debt problem remains unaddressed, the economist added.

Following the rate cut decision, the Turkish lira initially tumbled as low as 5.7681 against the dollar, economic news site Zero Hedge said. But the lira then promptly reversed all losses, and has since soared as high as 5.6579.

Economist Mahfi Eğimez said on Twitter that the lira had made gains as the market noticed that the overnight lending rate was set at 21.25 percent, and therefore saw that the real benchmark rate – the average of the one-week repo rate and the overnight lending rate – was 20.50 percent.

Murat Muratoğlu, another economist, told Ahval that the central bank could in theory indirectly affect loans, loan interest rates, deposit interest rates, and the exchange rates by changing its benchmark rate, but this was not the case anymore in Turkey.

He said the move would lead to a marginal drop in interest rates on deposits. “Banks have a limited amount of money for lending,” he said, adding that therefore loan rates would remain intact.

According Burhan Şenatalar, an academic and senior member of the main opposition Republican People’s Party (CHP), the significant rate cut had not led to exchange rate volatility as the markets were already expecting the decision. Due to the decreases in demand for exported goods, the demand for foreign currencies had also been limited, he added.

Şenatalar said the central bank’s decision had been based on the positive growth rate in the first quarter of 2019.

“But, even if this growth continues, it will take time to compensate for the contractions in previous periods. Therefore, decreases in interest rates will not be sufficient to ensure a rise in investment in the short run,” he said.

As a result the decision, would be unlikely to decrease unemployment, which, according to the latest figures for April, was at 13 percent.