Turkey: Where do we go from here?

Morten Lund, Analyst at Nordea Markets, suggests that yesterday’s emergency rate hike was clearly a step in the right direction in terms of restoring the central bank’s credibility, but believes that market participants once again will try to test the central bank to see whether they should still fear an erosion of the bank’s independence.

Key Quotes

“In this regard, hawkish and persistent communication from Erdogan, Simsek and the Economy minister, Zeybekci, will be important if CBRT wants to avoid another emergency hike in the comings days. Simsek and Zeybekci gave their full support yesterday, which is a good sign. Yet verbal intervention in the last couple of weeks has not proven enough to restore credibility and prevent the TRY from falling. Hence, we expect that CBRT will be forced to hike the key interest rate again and will do so at the next scheduled monetary policy meeting 7 June.”

“That also means that no emergency rate hikes are on the cards in the next couple of weeks. Our view is based on CBRT’s normal “reaction function” that is often behind the curve and Erdogan’s resentment towards further hikes. As a consequence, we keep our short-term negative bias on the TRY until the next policy meeting.”

“At the June meeting, we think that CBRT will hike with another 300 bp leaving the late liquidity window at 19.5%. This should be adequate to attract foreign inflows (current real yields still unattractive compared to volatility/hedging costs) and bring back liquidity to the market, but more importantly it will improve the investors’ faith in the central bank. Thus, the credibility towards the central bank is alfa and omega for the outlook of the Turkish lira, so if CBRT delivers another rate hike and keeps its hawkish bias, we believe the TRY will find some support in the coming months. But it will not be without high volatility and the risk of another TRY hit is high as external factors such as further USD appreciation or contagion worries may occur.”

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