Turkey may be ripe for an interest rate cut

Economists surveyed by Bloomberg predict Turkey will cut its interest rate on Thursday for the first time since 2016.

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    Bloomberg Photo  [Unspecified]
    Bloomberg Photo [Unspecified]

    Turkey is about to embark on one of the greatest central banking experiments in emerging markets - and the timing couldn't be better.

    Long a believer that high interest rates cause inflation, President Recep Tayyip Erdogan is finally putting that unconventional theory into practice by installing Murat Uysal as governor this month after firing his predecessor for failing to cut sooner.

    As the drumbeat of political pressure grows on central banks from the U.S. to India, Erdogan has one-upped his counterparts thanks to broad new powers granted to his office after last year's general election. A policy meeting on Thursday will show just how sharp a pivot the central bank is prepared to make.

    Turkey is ripe for monetary easing. A dovish turn in monetary policy globally and a downswing in inflation has left Turkey with the world's highest real rate. Powerful base effects will likely continue to choke off price growth in the months ahead.

    "To achieve an economic recovery, the central bank needs to ease fast enough and yet not so fast, given the implied weakness in the Turkish lira and imported inflation," said Sebastien Galy, a senior macro strategist at Nordea Investment Funds in Luxembourg.

    Erdogan's power grab was years in the making, a culmination of his distaste for high rates that's been linked to Islamic proscriptions on usury. In his view, producers have to pass on their higher borrowing costs to customers, so they raise prices.

    Erdogan promised to take more direct control over rate decisions in an interview last year and warned following a massive rate increase in September that "there is a limit" to his patience. The tipping point came when former Governor Murat Cetinkaya extended a policy pause to nine months in June, prompting Erdogan to call the 24% benchmark "unacceptable."

    The new governor, though, is boxed in between anxious markets and an impatient president. Although every economist surveyed by Bloomberg predicts Turkey will cut its interest rate on Thursday for the first time since 2016, estimates range from 50 basis points to 8 percentage points. The overnight forward implied yield on the lira suggests investors are pricing in a reduction of about 250 basis points.

    The economy continues a slow slog after recession and lending is on the decline again. Meanwhile, a deceleration continuing in inflation, which is already down almost 5 percentage points so far this year.
    The lira's fortunes have also reversed, especially after President Donald Trump indicated the U.S. may reassess a threat to sanction Turkey over its purchase of a Russian defense system. The currency is the best performer in emerging markets since the start of May.

    A wallop of monetary easing could easily unsettle the calm, however, especially if Turkey delivers cuts in the name of Erdogan's unorthodox views.

    If implemented, the "inane economic theory" could backfire by leaving Turkey with higher borrowing costs and inflation over the longer term, according to Refet Gurkaynak, a professor of economics at Bilkent University in Ankara.

    "Leaders like Erdogan and Trump are unified in wanting the central bank to lower interest rates, which is a standard short-sighted politician impulse and exactly why central bank independence was thought of in the first place," he said.

    SOURCE: Bloomberg