Sep 04 2019

Turkish lira rises to two-week high as slower inflation backs rate cut

Turkey’s lira climbed to a two-week high after a slowdown in inflation backed the authorities’ plans for further cuts to interest rates.

The lira gained 0.9 percent to 5.68 per dollar at 1:57 p.m. in Istanbul, outperforming other emerging market currencies and paring losses this year to about 6.9 percent.

Turkey’s central bank will meet to decide on interest rates on Sept. 12. Most economists are anticipating a cut of more than two percentage points to the benchmark lending rate of 19.75 percent. Monetary policymakers reduced the rate from 24 percent in July after keeping it steady since October.

Consumer price inflation in Turkey slowed to an annual 15 percent in August, the lowest level since May last year, from 16.7 percent in July. The reading beat economists’ expectations of 15.5 percent. Producer price increases eased sharply to 13.5 percent from 21.7 percent.

The central bank said on Wednesday that lira stability was contributing to the fight against inflation, which has slowed from a 15-year high of 25.2 percent in October. It also highlighted the role of energy and the price of basic goods.  

The Turkish lira, along with its emerging market peers, is also benefiting from fresh monetary easing by the European Central Bank and the U.S. Federal Reserve.

The ECB may enact a stimulus package that includes a rate cut and compensation for banks for the impact on their profits from negative rates, Reuters reported on Tuesday. The Fed may also reduce interest rates again at a meeting in two weeks.

But economists warn that the lira could become vulnerable again should the central bank approve another large rate cut resembling July’s 4.25 percentage point reduction. 

Turkish President Recep Tayyip Erdoğan replaced the governor of the central bank in July for failing to reduce interest rates quickly enough. Erdoğan maintains that cuts are needed to slow inflation, a departure from conventional economic thinking. He believes that lower interest rates reduce costs for businesses, allowing them to lower their prices.

Erdoğan’s son-in-law, Treasury and Finance Minister Berat Albayrak, appeared to back Erdoğan’s approach on Tuesday when he said that a slowdown in manufacturing prices would help drive inflation down in the months ahead. Consumer price inflation could slow to single digits in October before rising again, economists say.

The government has sought to reduce costs for businesses, including supplying them with cheap loans from state-run banks, to help drive inflation lower and boost economic growth. Its approach to dealing with inflation – linked to supply side economics – is unorthodox. The overwhelming majority of economists maintain that lower interest rates are inflationary.

Erdoğan has warned current central bank officials that they risk the sack should they fail to support the government’s low rates, pro-growth policies.

Turkey’s economy contracted for the third-straight quarter on an annual basis, figures published on Monday showed. Economic activity fell by 1.5 percent in the three months to June, the statistics institute said.