Turkey hikes rates, to keep tight stance until CPI improves

    Turkey's central bank raised all its key interest rates, including the one-week repo rate that was raised to 10 percent from 4.50 percent, and said a "tight monetary policy stance will be sustained until there is a significant improvement in the inflation outlook."
    The Central Bank of the Republic of Turkey (CBRT) also pushed up its rate corridor by raising the marginal funding rate - the ceiling in the band - to 12.0 percent from 7.75 percent, and the borrowing rate - the floor - to 8.0 percent from 3.5 percent.
    In addition, the central bank's rate on borrowing facilities for primary dealers via repo transactions was raised to 11.5 percent from 6.75 percent and the late liquidity lending rate was raised to 15 percent from 10.25 percent while the borrowing rate was retained at 0 percent.
    The CBRT, which last week saw its lira currency tumble, said recent domestic and external developments were having "an adverse impact on risk perceptions, leading to a significant depreciation in the Turkish lira and a pronounced increase in the risk premium."   
    "The Central Bank will implement necessary measures at its disposal to contain the negative impact of these developments on inflation and macroeconomic stability," the CBRT said after an extraordinary meeting of its monetary policy committee that was announced on Monday with the purpose of taking "the necessary policy measures for price stability."
     Turkey's lira currency started weakening against the U.S. dollar in February last year and fell 16 percent in 2013 as investors started to move funds out of more risky emerging markets and seek safer returns in advanced economies where growth is strengthening.
    Despite tightening measures since May, when the U.S. Federal Reserve signaled that it was preparing to withdraw its extraordinary stimulus, Turkey's central bank has not been able to arrest the fall in the lira, partly because it has shied away from raising benchmark rates and instead engineered tighter liquidity by increasing money market rates. 

    In addition to tightening liquidity, the CBRT spent $17.61 of its reserves from July through December defending the lira.


    Last week the lira tumbled, along with the currencies of the other emerging markets known as the "Fragile Five" - Turkey, India, Indonesia, South Africa and Brazil - and hit an all-time record low of 2.39 to the U.S. dollar on Monday before recovering after the Turkish central bank announced the surprise meeting of its monetary policy committee.

    Earlier today the lira was trading at 2.25 to the dollar, down almost 5 percent this year.

    The CBRT implicitly acknowledged that previous tightening measures had not been effective and said it would simplify its operational framework.
   The one-week repo rate, the benchmark rate until recently, will once again be used as the primary way to provide liquidity to markets instead of the marginal funding rate. After its regular policy meeting last week, the CBRT said it would raise its target for the interbank money rate, via the marginal funding rate, to 9.0 percent from 7.75 percent, during additional tightening days when one-week repo auctions were not held.

     Based on its new interest rates, the central bank said inflation is expected to reach its 5.0 percent target by mid-2015, but added that any new data may lead it to revise its policy stance.


     Earlier today the central bank wrote to the Turkish government to explain why inflation last year breached the inflation target, which was set jointly with the government.

    "The main factor causing inflation to exceed the target significantly in 2013 is the increases in the exchange rate in the second half of the year," the CBRT said, adding that the effect of the lower lira added 1.5 percentage points to the inflation rate by the end of the year.

    In addition, food prices rose by 9.7 percent last year, above the bank's 7.0 percent assumption, causing inflation to deviate from the target by 0.6 percentage points.

   Turkey's inflation rate rose marginally to 7.4 percent in December from November's 7.3 percent.  

   Although this was below July's 8.9 percent, a high for 2013, it was above the 5.0 percent target. 

    In its January inflation report, released earlier this week, the central bank raised its 2014 inflation forecast by 1.3 percentage points from the October report, with the impact of the lira's depreciation accounting for an estimated 0.5 percentage points and higher taxes for another 0.5 percentage points. 

    Inflation is projected to ease in the second half of 2014 but end the year at 6.6 percent after fluctuating between 5.2 and 8 percent, and then fall further in 2015, fluctuating between 3.1 and 6.9 percent, before stabilizing around the bank's 5.0 percent target. 

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