Central bank policy rate kept at 19 percent yet rate cut bets are open

The Turkish Central Bank Monetary Policy Committee (MPC) kept the one-week repo auction interest rate, which is the policy interest rate, steady at 19%.

The Bank emphasizes that inflationary pressures created in major economies, especially at those that carry out their vaccinations faster to speed up their exit from the pandemic, continue to exert threats to price stability in Turkey.

As for domestic demand, it is noteworthy that the MPC underlines the “adequacy” of the macro-prudential measures imposed so far to trim domestic demand that has soared on last year’s monetary and fiscal support.  Such “adequacy” wording means that the MPC sees no reason for higher policy rates beyond the current 19%.

The bank continues to claim that Turkey’s monetary policy is “tight” which has a positive effect on the current account deficit.  The Bank reiterates that the current account balance will turn positive. It further assumes that this will have a positive effect on the value of TL; eventually on the pace of inflation.  From this sentence, it can be deduced that the Bank either expects no further TL depreciation in the coming period; perhaps it is possible to make the assumption that the MPC anticipates that the TL might gain value.

However, the MPC maintains its “cautious stance” as it has kept the policy rate unchanged referring to “volatility in inflation and high levels of inflation expectations in the summer months”.  What it refers to as volatility is in fact higher inflation.  What it defines as the “rise in expectations” is in fact the gap between the central bank’s end of 2021 CPI inflation estimate of 14.1% and the market’ anticipation of 16-18% showing the lack of trust in the central bank.

“Taking into account the high levels of inflation and inflation expectations, the current tight monetary policy stance will be maintained decisively until the significant fall in the Inflation Report’s forecast path is achieved (from around 18% to around 14% in the last two months of 2021),” the MPC note says avoiding a direct signal of a looser monetary policy.

If it was not for President Erdogan’s TV appearance last week where he said that inflation would fall after August and interest rates would start to fall; it could be possible to conclude from this MPC text that there was no rate cut in the horizon of 2021.  Because in reality there is no room for lowering interest rates with the current level of inflation and inflation dynamics.  However, the fact that July inflation was laundered at just under 19% by TURKSTAT as described in the press yesterday by an anonymous TURKSTAT official further spurred fears of a rate cut coming sooner than later.

With the August inflation announcement showing an annual drop from 18.95% annual CPI inflation, combined with Erdogan’s harsh verbal interventions are raising concerns in the markets that interest rate cuts could be lowered starting from September.  The MPC text saying the policy interest rate will be kept “above inflation” feeds the expectation that interest rate cuts could commence if the TURKSTAT inflation data continuously points at annual gradual declines.

These monetary policy dynamics will continue to keep the TL fragile. In the coming weeks, TURKSTAT inflation data will clarify the confusion in this direction; any annaul declines is to be accompanied by rate cuts presumably.  If the Fed starts to reduce its bond-buying program for monetary tightening over the same period, which will reflect negatively on all developing countries’ currencies, including TL, it means that “possible” reductions in annual CPI inflation will not be permanent. Hence rate cuts will add further vulnerability on TL.

Although the MPC text does not include a clear message that the door has been opened to an interest rate cut, it is possible to catch insinuations. Erdogan’s statements and the fate of recent central bank governors are enough to keep the immature rate cut anticipations alive.  This will make TL volatile and fragile.


MPC text is below.

The Monetary Policy Committee (MPC) has decided to keep the policy rate (one-week repo auction rate) constant at 19 percent.

  • Worldwide speeding up of vaccination rollout, especially in developed countries, supports the global economic recovery. Nonetheless, economies advancing in their vaccination programs exhibit a stronger performance in economic activity by easing the restrictions. Strong recovery in global demand, high course of commodity prices, supply constraints in some sectors and rise in transportation costs have led to producer and consumer price increases internationally. Unfavorable effects of weather conditions in major agricultural commodity exporting countries are observed on global food prices. The effects of rising global inflation and inflation expectations on international financial markets remain significant.
  • Leading indicators show that domestic economic activity remains strong in the third quarter, with the help of robust external demand. The acceleration of domestic vaccination rollout facilitates the recovery in services and tourism sectors, which have been adversely affected by the pandemic, and leads to a more balanced composition in economic activity. Commercial loan growth exhibits a mild course. The Committee monitors the adequacy of the implemented macroprudential measures to curb personal loan growth, which recently displayed a rise due to the reopening and deferred demand. Favorable external demand conditions and current tight monetary policy impact the current account balance positively. The current account is expected to post a surplus in the rest of the year due to the strong upward trend in exports, and the strong progress in the vaccination program stimulating tourism activities. The improvement in the current account balance is important for the price stability objective.
  • In addition to the recent increases in import prices and administered prices, demand conditions, supply constraints in some sectors, possible volatility in inflation during the summer due to the reopening, and high levels of inflation expectations continue to pose risks to the pricing behavior and inflation outlook. The increase in inflation in July was driven by the rise in food inflation, due to supply-side effects in some products led by climate conditions, the high levels of international agricultural commodity and food prices, as well as the effects of the reopening. On the other hand, the decelerating impact of the monetary tightening on credit and domestic demand is being observed. Taking into account the high levels of inflation and inflation expectations, the current tight monetary policy stance will be maintained decisively until the significant fall in the Inflation Report’s forecast path is achieved. Accordingly, the MPC has decided to keep the policy rate unchanged.
  • The CBRT will continue to use decisively all available instruments in pursuit of the primary objective of price stability. The policy rate will continue to be determined at a level above inflation to maintain a strong disinflationary effect until strong indicators point to a permanent fall in inflation and the medium-term 5 percent target is reached.
  • Stability in the general price level will foster macroeconomic stability and financial stability through the fall in country risk premium, reversal in currency substitution, accumulation of foreign exchange reserves and perpetual decline in financing costs. This would create a viable foundation for investment, production and employment to continue growing in a healthy and sustainable way.