After enduring a punishing couple of weeks in global financial markets, the Turkish central bank reacted more decisively than most analysts had expected to prove its anti-inflation credentials.
Governor Durmus Yilmaz and the other four members of his still incomplete monetary policy committee lifted the benchmark borrowing cost by 175 basis points to 15%, the first hike in almost 15 years.
“It’s a really positive sign that they are ready to stand and fight for their inflation target, something that’s really necessary,” Michael Discher-Remmlinger, a fund manager at Pimco, told Emerging Markets. “It was a very proper and solid response.”
An ongoing reshuffle on the monetary policy committee, including the replacement of respected central bank governor Sureyya Serdengecti, had raised fears that policy makers might be slow to react to a developing crisis in the economy. Turkey has been one of the worst hit countries following weeks of capital flight from emerging markets, enduring a slump of almost 20% in the value of the lira last month.
An already jumpy market was battered again last week by the release of disappointing May inflation data. The Consumer Price Index came in 1.88% higher than the previous month and over 9.9% up on the year, more than double the consensus forecasts. Additionally the impact of the steep drop in the lira has yet to be felt and will likely continue to bolster prices in coming months, meaning the central bank will almost certainly miss its 5% inflation target this year. However, following today’s bold move the 2007 goal still appears attainable, analysts predicted.
Senior government officials, insist they will stick by the published objectives. Deputy Prime Minister Abdullatif Sener told business leaders on Monday that the 5% rate for 2006 is still mathematically possible.
Rising borrowing costs, coupled with the depreciation of the currency, should help tackle Turkey’s swollen current account deficit which climbed 50% to a record $23 billion last year. “The overall influence on the current account is likely to be nothing but positive,” said Tevifik Aksov, Deutsche Bank’s chief Turkish economist.
The IMF has warned that the current account gap threatens to destabilise the economy: “Any country running a large current account deficit is exposed if market sentiment were suddenly to deteriorate,” Hugh Bredenkamp, senior resident representative for the IMF in Ankara, told Emerging Markets. It is “crucial” for the government to control its spending to cap the deficit, he said.
While today’s rate rise is viewed as good news for the Turkish economy, investors both in fixed income and stocks are unlikely to rush back in.
“The move [to raise interest rates] seems not so supportive of equity market” because of the impact on economic growth and corporate balance sheets, Deutsche’s Aksov warned.
Discher-Remmlinger said he expects the lira to fall further: “I think we’re not yet done with the currency,” he said by telephone. “I wouldn’t issue a buy recommendation as we speak, it’s too early.” Alia Yousef at Standard Bank agrees that the extent of the drop in the lira hasn’t been enough to make the investment opportunity attractive. The Turkish currency spiked upwards in the immediate aftermath of the rates announcement, before returning to around levels seen before the decision.