Turkish central bank vows action to stop currency tumbling

The central bank governor said he wouldn’t hesitate to tighten the monetary policy if needed

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Turkey’s central bank governor raised expectations for an emergency interest rate hike on Tuesday, denying he was hostage to political pressures and vowing decisive action to fight rising inflation and a tumbling lira.
Erdem Basci said the bank would not hesitate to tighten monetary policy in a “lasting way” if needed and asserted the bank's independence amid investor concern that it has shied away from rate hikes under pressure from the government.

He ruled out any imposition of capital controls, saying such moves were “not in our dictionary,” and said the sort of tightening moves used by the bank so far against lira volatility were “way more effective” when backed by interest rates.

Prime Minister Tayyip Erdogan, keen to maintain economic growth ahead of an election cycle starting in two months, has been a vociferous opponent of the higher borrowing costs sometimes needed to bolster currencies, railing against what he describes as an ‘interest rate lobby’ of speculators seeking to stifle growth and undermine the economy.

“Despite all the defamation campaigns, all the sabotage, the Turkish economy is pressing ahead in a solid and resilient way,” Erdogan told a meeting in parliament of his ruling AK Party, citing record car, fridge and washing machine sales last year.

His tough stance on rates has left the central bank struggling to contain the lira’s precipitous slide. Investor confidence has been damaged by a corruption scandal shaking the government, fears about a power struggle and the global impact of a cut in U.S. monetary stimulus.

“In Turkey, politicians publicly criticize or praise central bank decisions ... I don’t think it threatens the bank’s independence,” Basci told a news conference to announce the bank’s quarterly inflation report.

“Nobody should have any hesitation that the central bank will use all available tools. The bank will not hesitate to take steps to make lasting tightening in monetary policy if deemed necessary,” he said.

The lira firmed on his comments to 2.2601 against the dollar from 2.3120 late on Monday, having touched a record low of 2.3900 on Monday morning.

The cost of insuring Turkish debt meanwhile eased from Monday’s 19-month highs, according to data from Markit.

The bank sharply raised its inflation forecast for the end of the year to 6.6 percent, heightening market expectations that it will hike rates at its first extraordinary monetary policy meeting since August 2011, the height of the euro zone crisis.

It is expected to raise its lending rate - the cost of its overnight loans to Turkish lenders - by 225 basis points to 10 percent, according to the median forecast in a Reuters poll of 31 economists taken on Monday.

The bank will announce the outcome of the meeting at midnight locally (22:00 GMT).

Will it be enough?

Erdogan congratulated the central bank last week after it left interest rates on hold, despite the lira’s tumble, while his new economy minister came out a day before the meeting saying the bank should not hike.

“Stand firm, don’t raise,” the pro-government Yeni Safak newspaper said in its main front page headline on Tuesday, alongside a picture of Basci.

“The interest rate lobby based in London and New York virtually blackmailed the central bank yesterday, pushing the lira has high as 2.39 against the dollar,” the paper said.

Thirty respondents in the Reuters poll, a wide sample of Turkish and international banks, forecast a rate hike, with estimates ranging from a rise of 125 basis points to 425. Only one forecast the bank would leave rates unchanged.

There was less consensus over whether such a move would be enough to stabilize the lira and tame inflation, with 12 economists saying yes and seven saying no, citing the need for structural reforms and political stability.

“A one-off rate hike - even an aggressive one - is one thing, a radical and irrevocable change in the conduct of Turkish monetary policy in an election year and when growth is slowing is quite another,” said Nicholas Spiro, head of Spiro Sovereign Strategy in London.

The graft scandal, which triggered the resignation of three ministers and detention of businessmen close to Erdogan, has grown into one of the biggest challenges of his 11 years at the helm, just as he prepares for local elections in March and a presidential race he is expected to contest five months later.

His reaction, purging the police force of thousands of officers and seeking tighter government control over courts, has been criticized by the European Union and raised investor concern over the rule of law and independence of state institutions.

Reluctant up to now to make an outright rate hike, the central bank has struggled to defend the lira instead by burning through its forex reserves and trying to squeeze up borrowing costs on the margins - a battle it has clearly been losing.

The bank raised its mid-point forecast for year-end inflation to 6.6 percent from a previous forecast of 5.3 percent, well above its target rate of 5 percent.

Basci said inflation would slow from the second half of 2014 and forecast the 2015 inflation mid-point at 5 percent.