Turkey holds rate but softens hawkish policy stance

      Turkey's central bank maintained its key interest rate and "tight monetary policy stance," as widely expected, but dropped its earlier commitment of maintaining this stance for an extended period and that it could even raise rates further, signaling a clear softening of its hawkish tone.
      Instead of its previous pledge of keeping a tight policy stance "decisively" and for an extended period, the Central Bank of the Republic of Turkey (CBRT) today said it would use "decisively" all instruments in pursuit of price stability and the policy rate would be set above inflation to maintain a disinflationary effect until there is a permanent fall in inflation and the medium-term inflation target is reached.
     The shift in tone comes after a highly anticipated first monetary policy meeting under its new governor - the bank's fifth in the last decade - and the verdict by the foreign exchange market was swift.
     The Turkish lira immediately fell just over 1 percent to 8.133 to the U.S. dollar, before recovering some of its loss to 8.09 but continuing the slide since March 21 when current governor Sahap Kavcioglu took over after his predecessor, Naci Agbal was fired by Turkey's strong-will president, Tayyip Erdogan.   

     Agbal was the third governor to be let go by Erdogan since Murat Cetinkaya was fired in 2019 and Murat Uysal was fired in 2020, repeatedly unsettling investors who increasingly doubt the central bank's commitment to fight inflation under the leadership of Erdogan.

    Turkey's inflation rate has been volatile in the last few years, mainly due to the impact of the lira's exchange rate.

     After plunging from over 100 percent in January 1998 to below 8 percent in 2005, inflation in Turkey was relatively contained below 10 percent for more than a decade when the lira's decline was relatively steady.

    But in early 2018 the lira's decline picked up speed and then plunged in July and August that year, a move Cetinkaya responded to by raising interest rates sharply, helping reverse some of the lira's losses, while inflation spiked to 25.24 percent in October 2018.

     Inflation remained close to 20 percent for the next six months but the impact of the high interest rates and a relatively steady lira helped push down inflation to 8.55 percent in October 2019.

     But the arrival of COVID-19 last year undermined the lira's stability and it lost almost 20 percent of its value in 2020 though its fortunes appeared to have changed in November last year with the arrival of Agbal at the central bank who quickly raised rates, helping boost the lira and the confidence of investors.

     But this peace was shattered in March when Erdogan fired Agbal after his third rate hike - the bank's fourth since September 2020 - and since this change of governor the lira has lost over 10 percent to trade at 8.09 to the dollar today, down 8.8 percent since the start of 2021 and down 26 percent since the start of 2020.

     Inflation, meanwhile, has continued to rise for the last five months to 16.19 percent in March, more than 3 times the central bank's medium-term target of 5.0 percent.

      CBRT left its one-week repo rate at 19.0 percent.

     The Central Bank of the Republic of Turkey issued the following statement:

     

"Participating Committee Members

Şahap Kavcıoğlu (Governor), Mustafa Duman, Elif Haykır Hobikoğlu, Uğur Namık Küçük, Oğuzhan Özbaş, Emrah Şener, Abdullah Yavaş.

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

The global economy, having contracted sharply in 2020 due to the pandemic, continues to recover on the back of accommodative policies and positive developments in the vaccination process. This improvement process is determined especially by the acceleration in manufacturing industry activity and global trade. While the upward trend in commodity prices has decelerated, the effects of the rising global inflation expectations on international financial markets remain significant.

Despite the constraining effect of the pandemic, domestic economic activity is strong, led by domestic and external demand. Manufacturing industry activity exhibits a strong momentum, whereas the weak course continues in the services sector, which has been adversely affected by the pandemic restrictions. Nevertheless, risks for economic activity exist in either direction depending on the progress of the pandemic and the vaccination process. Notwithstanding the rise in exports and the fall in gold imports, strong domestic demand and commodity prices continue to adversely affect the current account balance. While commercial loans exhibit a moderate course, an upward trend is observed in consumer loan growth despite tightening financial conditions.

Demand and cost factors, supply constraints in some sectors, and high levels of inflation expectations continue to pose risks to the pricing behavior and inflation outlook. The decelerating impact of the current monetary stance on credit and domestic demand is envisaged to become more significant in the upcoming period. Accordingly, the MPC has decided to maintain the tight monetary policy stance by keeping 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.

The stability in the general price level will foster macroeconomic stability and financial stability positively 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.

The Committee will continue to take its decisions in a transparent, predictable and data-driven framework.

The summary of the Monetary Policy Committee Meeting will be released within five working days."

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