Turkey bank expected to cut rates, but is easing cycle drawing to a close?

Turkey’s central bank is expected to approve a 10th-straight reduction in interest rates at a meeting on Thursday.

Economists and analysts are almost united in a prediction that interest rates will fall. But they are divided about whether the bank has reached the end of its rate-cutting cycle, or whether it may soon need to raise them to stem inflation.

The central bank in Ankara will reduce the benchmark one-week lending rate by 25 basis points to 8 percent, according to the median estimate in a Bloomberg poll of 20 analysts.

More than half of the analysts predicted the 25-basis point reduction, with two expecting no change and the remainder a cut of 50 basis points. The median estimate in similar surveys by Reuters and the state-run Anadolu news agency was also for a reduction to 8 percent. None predicted a decline of more than 50 basis points. The bank has surprised with the size of its rate cuts in the past.

Turkey’s central bank has slashed interest rates from 24 percent in July last year, when President Recep Tayyip Erdoğan sacked and replaced its governor for failing to ease monetary policy. Consumer price inflation stood at 11.4 percent in May, meaning real interest rates are negative.

"Interest rates are below inflation and we have gotten close to the central bank's year-end inflation estimate," said Enver Erkan, an economist at Istanbul broker Tera, according to Reuters. He said that the bank would likely stick to small cuts or hold rates steady in the coming months.

Analysts differ over whether the rate cut expected on Thursday will be the central bank’s last. Some point to inflation and the dangers of higher price increases as the economy recovers from the impact of the COVID-19 pandemic. Others are more circumspect, anticipating that Turkey may continue to reduce borrowing costs despite negative real interest rates.

Annual consumer price inflation in Turkey has accelerated into double figures from 8.6 percent last October.

Erdoğan says higher interest rates are inflationary - confounding conventional economic theory that interest rates should be raised to slow price increases - and has called on the central bank to reduce them both to stem inflation and encourage economic growth.

Nigel Rendell, director for Europe, the Middle East and Africa at New York-based Medley Global Advisors, predicted a 50-point reduction on Thursday, Anadolu news agency reported.

The Turkish authorities appear determined to do everything they can to speed up the economic recovery, Rendell said.

Real interest rates in Turkey – calculated by subtracting annual inflation – are among the lowest in the world. They stand at a negative 3.1 percent compared with a negative 0.6 percent in the Euro Area, minus 0.4 percent in Britain and a negative 0.3 percent in South Africa, according to Bloomberg data.

Low rates in Turkey dissuade foreign investors from buying Turkish bonds, potentially impacting the value of the lira. The currency fell to a record low of 7.269 per dollar in early May, partly due to concerns over the level of interest rates, along with the central bank’s sparse foreign currency reserves.

U.S. investment bank Goldman Sachs is warning of the risk that interest rates in Turkey may soon have to rise, Bloomberg reported on Wednesday. Meanwhile, JPMorgan and Barclays are both predicting that the rate cut will be the last this year, it said.

"The bank is likely to ease monetary policy further in an effort to spur a rapid credit-led economic recovery," said Phoenix Kalen, emerging markets strategy director at Paris-based Societe Generale, according to Anadolu. Kalen pointed to improving global risk sentiment and a relatively stable lira.

The lira fell less than 0.1 percent at 6.85 per dollar in morning trading on Thursday.