July 24, 2018 / 11:08 AM / 5 months ago

Turkey's central bank leaves policy rate unchanged, defying expectations

ISTANBUL (Reuters) - Turkey’s central bank left interest rates on hold on Tuesday, bucking market expectations of a hike and sending the lira sharply weaker, in its first policy decision since President Tayyip Erdogan was re-elected with new executive powers.

The bank, already the focus of investor concern over its perceived lack of independence from Erdogan, cited signs of weakening domestic demand as the reason for keeping the benchmark rate at 17.75 percent.

The meeting was widely seen by as a test of how the bank would act under the new executive presidential system, which went into effect this month and gave Erdogan sweeping new powers. In one of his first acts since being sworn in, he named his son-in-law Berat Albayrak as finance minister.

The decision also appeared to fly in the face of recent comments from Albayrak, who said over the weekend he would not fight with the markets.

“We like to hear policymakers telling us that they will work with markets and bring inflation down and respect the independence of central bank, but we want to see these words backed up with action,” said Tilmann Kolb of UBS Wealth Management.

“We have seen constantly worsening inflation dynamics... and in that situation you would have expected the central bank to act,” Koblb said.

The lira TRYTOM=D3, which has lost some 20 percent of its value so far this year, weakened as far as 4.94 against the dollar following the decision, from 4.7605 directly before. It was at 4.8850 at 1253 GMT, some 3 percent weaker on the day.

Worries that Erdogan’s influence over monetary policy are eroding the bank’s ability to fight inflation have sparked the sell-off in lira this year. Inflation hit its highest in 14 years in June, at 15.39 percent.

‘MORE DANGEROUS’

Fifteen of 16 economists in a Reuters poll had forecast an increase, with an increase of 100-125 basis points considered the most likely option.

The sole economist to predict the bank would keep rates on hold, Muammer Komurcuoglu of Is Invest, said the bank was probably concerned about growth in the second half of this year.

The divide between growth and inflation is at the heart of investor concerns about Turkey. Erdogan, a self-described “enemy of interest rates” wants to see lower borrowing costs to fuel economic growth, particularly through construction. Investors fear the economy is overheated and want to see hefty hikes.

“External demand maintains its strength, while signs of decelaration in domestic demand become more visible,” the bank’s monetary policy committee said in a statement. “The committee assessed that it might be necessary to maintain a tight monetary stance for an extended period.”

The central bank has raised rates by 500 basis points since late April in an effort to put a floor under the currency.

“Utterly mystifying,” said Paul McNamara, emerging markets investment director at GAM Investments in London. “Anything that undermines the lira is likely more dangerous than hikes.”

“While the (central bank) is nominally independent, it’s unlikely that this decision isn’t politically influenced. At the moment, the damage from higher yields and weaker lira is much worse than 125bps in rate hikes would have been.”

Additional reporting by Daren Butler and Ali Kucukgocmen in Istanbul, Nevzat Devranoglu in Ankara and Sujata Rao in London; writing by David Dolan; editing by Larry King

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