Turkey’s central bank finally realizes the rise in inflation thus no rate cut… well that was a surprise

Today’s Monetary Policy Committee (MPC) produced no rate cuts despite 25 basis points expected on the average by the market and the MPC decided to keep the policy rate (one-week repo auction rate) constant at 8.25 percent.

Following the announcement, Turkish lira slightly gained ground versus the dollar to 6.86 to 6.83; though the recovery was not maintained.

The bank’s decision to halt the monetary easing that began in July 2019 from 24.00 percent down to 8.25 percent resulting with a massive rate scheme, was based on the rise in the core inflation and food price inflation despite the crashing domestic demand. Currently the core inflation is at 10.3 percent with the food price inflation at 12.9 percent.

The bank also stressed weakening global growth with respect to COVID-19 in the second quarter, normalization steps taken by several countries have contributed to a partial recovery. While adding that uncertainties remained high creating a need to follow capital flows, financial conditions, international trade and commodity prices.  

While Treasury and Finance Minister Albayrak sees Turkey engaging to a V shaped recovery in 2H20 and to end year with a slightly positive GDP growth, the IMF’s revised GDP expectation is still at -5% GDP for Turkey. In fact, the average market call ranges in 3.5-5% GDP contraction for 2020. Thus, as the bank expects to see slower inflation late down in the year, such a trend combined with a contracting GDP could as well motivate the bank to deliver a few more rate cuts in 4Q20. Yet, as for the 3Q20, no more rate cuts should be expected before Turkey’s core inflation slides back into single digits to around 7-8% from the current 10.3%. That could as well happen not before 2021.

Here is the note issued following the MPC:

  • While the weakening in economic activity became more pronounced in April, economic recovery has started as of May following gradual steps towards normalization. In order to contain negative effects of the pandemic on the Turkish economy, it is of crucial importance to ensure the healthy functioning of financial markets, the credit channel and firms’ cash flows. In this respect, recent monetary and fiscal measures contribute to financial stability and economic recovery by supporting the potential output of the economy. Recently, exports and tourism revenues declined due to the pandemic. However, the recovery in exports of goods with the ongoing normalization and low levels of commodity prices will support the current account balance in the upcoming periods. 
  • Despite the restraining effects of aggregate demand conditions, pandemic-related rise in unit costs have led to some increase in the trends of core inflation indicators. International commodity prices have continued to restrain consumer inflation, while food inflation has risen due to seasonal and pandemic-related effects.  As the normalization process continues, supply-side factors, which have prevailed recently due to pandemic-related restrictions, will phase out and demand-driven disinflationary effects will become more prevalent in the second half of the year. Accordingly, considering all factors affecting the inflation outlook, the Committee decided to keep the policy rate unchanged. 
  • The Committee assesses that maintaining a sustained disinflation process is a key factor 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, monetary stance will be determined by considering the indicators of the underlying inflation trend to ensure the continuation of the disinflation process.