Turkish rate hike: a big step for Turkey, a small step for emerging markets

  • The Turkish central bank hiked the interest rates to 24%, more than expected. 
  • The Turkish Lira jumped, and the EUR/USD ticked higher.
  • The ramifications may be felt all the way to Argentina.

The Central Bank of the Republic of Turkey raised rates from 17.75% to a whopping 24%, above expectations which stood at a hike of 22% or 21%. Last week, the Finance Minister said that the central bank is independent, paving the way for a hike.

However, President Recep Tayyip Erdoğan delivered a speech two hour before the event and reiterated his long-held position against higher rates. His unorthodox views have pushed the Turkish Lira lower and scared investors.

His words sent the lira lower once again, making the CBRT announcement even more dramatic. The CBRT defied the all-powerful president and sent the lira higher. The USD/TRY nearly touched 6.00 after surpassing 6.50 earlier.

A one-time defiance of Erdoğan doe not mean the CBRT is fully independent. FXStreet expert Joseph Trevisani says:

The Turkish Central Bank's surprise rate hike to 24% has temporarily stabilized the Lira, with the currency gaining more than 3% versus the Dollar in the immediate aftermath.  That is the easy part. The hard part will be convincing the market that it is truly independent of President Erdogan.

Convincing the markets is not easy.

The EUR/USD was also influenced by the move, ticking up some 20 pips. Three euro-zone banks have significant exposure to Turkey. Also, the nation that straddles Asia and Europe has close trade relations with the euro-zone. 

Argentina is watching

But while the immediate reaction in the EUR/USD was minimal, the move by the Turkish authorities may have a more dramatic impact on other emerging markets. Contrary to Turkey, the authorities in Argentina "played by the rules" all the way, raising interest rates to a whopping 60%. That helped the Peso stabilize but not recover. It is safe to say that somebody in Buenos Aires is watching the events unfolding in Ankara.

If the CBRT hike succeeds in strengthening the Lira, Argentina and other central banks in emerging markets may take further steps and push rates even higher.

But if Turkey's eventual surrender to the international orthodoxy does not succeed, other counties may be discouraged to choke their economies in pursuit of strengthening their currency without success.

Why can the big rate hike fail? As Trevisani said, it is not so easy convincing investors that the central bank is fully independent. In addition, inflation may remain high for some time and other issues may arise.

All in all, the Fed's hikes after years of the cheap lending trigger the troubles for emerging markets that sometimes hit the shores of developed economies. The U-turn in Turkey's policy is a significant chapter in the current crisis, but as long as the Fed raises rates, this is far from being the end of the story.

More: Emerging markets currency outflows can ignite a developed world recession

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