FOCUS: Turkish Central Bank Stays Dovish, May Cut More

   By Christopher Emsden 
   Of DOW JONES NEWSWIRES 
 

Turkey's central bank said Tuesday its impressive rate-cutting cycle isn't over and hinted that more monetary easing could come if the domestic economy stumbles or if rising flows of foreign capital push the Turkish lira higher.

Also Tuesday, Fitch Ratings put Turkey's long-term double-B issuer default ratings on "watch positive," underscoring growing confidence in Turkey's monetary and fiscal fundamentals.

Governor Durmus Yilmaz presented the central bank's quarterly inflation report Thursday, keeping its forecasts roughly stable from July despite the expectation of higher oil prices. Inflation should steadily decline to 4.8% by the third quarter of 2012, with inflation targets being hit both next year and in 2011, according to the new projections.

"The revised forecasts indicate that the output gap will not close soon, supporting disinflation even when policy rates are kept at low levels for an extended period," Yilmaz said.

He also cited the view of the bank's monetary policy committee, which earlier this month reiterated that it would be "necessary for monetary policy to maintain an easing bias for a long period of time."

Turkey's output gap - a measure of how far below potential an economy is performing - has widened as its industrial sector was battered by the contraction in international trade, which has pushed capacity-utilization rates to below 70% and triggered a spike in unemployment.

Indeed, the central bank wrote a formal letter to the government Tuesday explaining why inflation, which was 5.3% over the summer, was so far below the 2009 target of 7.5%.

Yilmaz warned that growth doesn't look robust and that domestic demand is likely to flatten after rising because of tax incentives in the spring. Still, he said gross domestic product, which fell almost 15% in the first three months of this year, would begin growing in annual terms starting in the fourth quarter of 2009. But he also said the output gap will remain disinflationary until the middle of 2012.

Because Turkey's central bank has slashed its policy interest rate by 10 percentage points to 6.75% since last November, the subdued outlook on price pressures doesn't translate into many more rate cuts.

Most analysts expect at least one more rate reduction next month. That would leave the policy rate only one percentage point above the central bank's expected inflation rate in 2010 - when markets are pricing in rate hikes that analysts also expect.

But Yilmaz also underscored two scenarios under which more rate cuts are delivered. One is if growth is surprisingly weak, and the other is if belief in a global economic recovery led by emerging markets spurs strong capital flows into the country, leading to a stronger lira and consequently lower imported inflation.

That amounts to a promise to cut if things are too good, or too bad, said Murat Berk, an economist for UniCredit in Istanbul.

"The bank seems to view this year's disinflation mostly as externally induced and wants to be in a more advantageous staring position of lower interest rates and a weaker currency once the external factors' influence diminishes," Berk added.

Yilmaz also said that the central bank will purchase government securities in the secondary market, outlining how it will conduct such transactions on Dec. 10.

The announcement was largely expected because the central bank has begun focusing on liquidity-related measures - such as lowering required bank reserve ratios and offering foreign currency to local lenders - to complement its rate cuts.

Because purchases of government bonds appear to resemble quantitative-easing strategies deployed by the U.S. Federal Reserve, "such a move will require an impeccable communication strategy," said Ilker Domac, an economist for Citigroup in Istanbul.

If the purchases are limited to rolling over the roughly TRY9 billion ($6 billion) in government bonds maturing next year that the central bank acquired as part of its mopping up of the 2001 financial crisis, the impact should be neutral, Domac said.

However, if they are perceived as a way of providing sure financing of increased government spending, such action by the central bank would probably push up longer-term Turkish borrowing costs, blunting the purpose of rate cuts, Domac added.

-By Christopher Emsden, Dow Jones Newswires; +39-02-58-21-99-05; chris.emsden@dowjones.com

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(END) Dow Jones Newswires

October 27, 2009 10:17 ET (14:17 GMT)


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