October 28, 2011 / 12:11 PM / 9 years ago

Analysis - Turkey central bank action may aid lira

ISTANBUL (Reuters) - The Turkish lira may rise more on the central bank’s five-pronged monetary policy action plan unveiled this week, analysts said, but there is a risk of market confusion over the complex policy mix.

Turkish lira banknotes are seen in this picture illustration taken in Istanbul October 18, 2011. REUTERS/Murad Sezer

Overall, analysts voiced relief that the bank had returned to a policy focussed on ensuring price stability, ending its previous unorthodox policy aimed at deterring hot money flows that received widespread criticism.

Governor Erdem Basci said on Wednesday that the bank had decided to tighten policy to avoid a more permanent depreciation in the lira and as a response to inflation expectations.

“They have shifted bias and have started tightening policy, which is welcome. The message on the inflation side is much more focussed than it used to be,” said Claire Dissaux, investment strategist at currency fund Millennium Global in London.

But while the bank has raised the overnight lending rate to 12.5 percent from 9 percent, it has left its key one-week repo rate unchanged at 5.75 percent, greatly widening the corridor between the rates it offers.

The central bank said that would give it greater flexibility in managing its rates, but analysts said this may create confusion.

Furthermore, on Thursday the central bank cut the reserve requirement ratios (RRRs) on lira deposits of up to six months’ maturity in a move it expects will provide some 11 billion lira (3.9 billion pounds) of liquidity to the market.

“All in all, the combination of all these instruments could be a bit confusing for investors,” said Tufan Comert, strategist at Garanti Securities.

He added that in addition to the RRR cut the central bank would tighten lira liquidity via its open market operations.


Analysts said that on balance, the series of moves would support the currency. Indeed, after the central bank’s announcement on Wednesday, the lira hit 1.7425 versus the dollar, its strongest level in 1-1/2 months.

“On the forex front, the central bank has sent a very strong signal that it really cares and will now fight tooth and nail to keep the lira in the 1.7-1.9 range against the dollar, with a preference to have the currency at the bottom end of the range,” said Timothy Ash, economist at RBS.

Against a euro/dollar basket the lira recovered to 2.0909, its strongest in a month. Analysts said they expected the bank to try to settle lira around the 2.05 level against the basket.

On Friday, Credit Suisse issued a note recommending investors go long on the lira against the basket as the sharp rise in short-term interest rates was supporting the currency.

“We recommend going long the lira against the basket with a target of 2.02 (current spot 2.115) and a stop loss at 2.18. The current 3-month forward rate of the Turkish lira versus the basket is around 2.16,” Credit Suisse concluded.

Earlier this month, the lira had been wallowing down almost 20 percent since the start of the year, making it one of the worst performers among emerging markets. Its gains over the last few days mean it is now down 16 percent for the year.

Many analysts said the gathering pace of depreciation was a big factor behind the central bank recognition of upside risks to inflation, for which it ramped up its year-end forecast to a mid-point of 8.3 percent from 6.9 percent previously.

Consumer prices rose 9.24 percent in the year to the end of September, way above the bank’s official year-end target for annual inflation of 5.5 percent, raising concerns over inflationary pressures.

Analysts also noted that the central bank’s move to increase bank borrowing costs would tighten lira liquidity by forcing banks to raise their deposit and loan rates, thereby slowing economic growth and curbing inflation expectations.

“Assuming the overnight borrowing rate will be around 12 percent in the coming weeks, the new scheme corresponds to a significant monetary tightening and should definitely support the lira in the short term,” said Yarkin Cebeci, economist at JP Morgan.

In the wake of Wednesday’s announcement, deposit and loan rates rose respectively by 150 and 250 basis points, while the benchmark government bond yield rose nearly 100 basis points.

Since its monthly meeting last week, the central bank has reduced market liquidity, and the repo rate has risen nearly 300 basis points to nearly 11 percent, obliging Turkish primary dealers to use the central bank repo facility.

“The central bank will manage one-week repo volume and the reserve requirements so as to ensure that market rates are closer to the upper range of the corridor at times of inflationary pressure and closer to the lower band when all is well,” wrote Cem Akyurek, chief economist at Deutsche Bank.

Many analysts highlighted that the new measures give the central bank flexibility but create uncertainty for investors, and said the bank should revert to using its policy rate as its main policy instrument once the global outlook becomes clearer.

Currently the central bank policy rate, one-week repo rate stands at an all-time low of 5.75 percent, unchanged since early August.

“They delivered tightening via the back door, but I would have been happier with a clearer path with rate increases,” said Millennium Global’s Dissaux.

Editing by Simon Cameron-Moore

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