Turkey cuts rate 2nd time, limited room for more cuts

      Turkey's central bank cut its key interest rate for the second month in a row by much more than expected, dealing another body blow to the lira's exchange rate, and said there was "limited room" for further rate cuts during the remainder of this year.

     The Central Bank of the Republic of Turkey (CBRT) cut its policy rate, the one-week repo auction rate, by another 200 basis points to 16.0 percent following a 100-point cut in September, when the rate was cut for the first time in two years.

     The rate has now been cut by 300 points since the current central bank governor, Sahap Kavcioglu, was installed by Turkey's strong-willed president, Tayyip Erdogan, in March after his predecessor Naci Agbal became the third governor to be fired in less than two years.

      The rate cut was twice the amount expected by analysts and comes only a few days after the Turkish Industry and Business Association in a report called for a fundamental reform of economic policy making, - a diplomatic but still a clear critique of Erdogan - and underlined the importance of an independent central bank for the country's long-term economic growth and development.

      The Turkish lira continued to plummet to new record lows, falling another 1.6 percent in the aftermath of the rate cut to 9.43 to the U.S. dollar.

      Since March 20, when Kavcioglu took over the central bank, the lira has lost 22 percent of its value against the dollar to be down 22 percent this year and down 37 percent since the start of 2020.

      The fall in the lira illustrates how foreign investors are turning their backs on Turkey, with data from the Institute of International Finance (IIF) earlier today showing capital flows into Turkish bonds and stocks falling since the September rate cut.

      The rate cut comes despite the steady rise in Turkey's inflation rate, which is now almost four times the bank's medium-term target of 5.0 percent.

      Headline inflation rose to 19.6 percent in September, the highest rate since March 2019, from 19.25 percent in August while core inflation - which Kavcioglu recently has emphasized - rose to 16.98 percent from 16.76 percent.

      CBRT said the recent rise in inflation was driven by higher food and import prices, especially energy, along with supply-side constraints, higher administered prices and stronger demand.

     "It is assessed that these effects are due to transitory factors," the bank said, adding the impact of past monetary tightening was having a dampening impact on credit and domestic demand along with commercial loans and personal loan growth.

      As in September, the central bank said it would "continue to use decisively all available instruments" until there is a permanent fall in inflation and the medium-term inflation target is achieved.

     "Nevertheless, the Committee assessed that, till the end of the year, supply-side transitory factors leave limited room for the downward adjustment to the policy rate," CBRT said.

     Turkey's economy has continued to grow since the second quarter of last year, with its gross domestic product up 21.7 percent year-on-year in the second quarter of this year from 7.2 percent in the first quarter.

     "Leading indictors show that domestic economic activity remains strong, with the help of robust external demand," CBRT said, adding domestic vaccinations have helped a recovery of services, tourism and related sectors.

      The Central Bank of the Republic of Turkey issued the following press release:

  

"Participating Committee Members

Şahap Kavcıoğlu (Governor), Taha Çakmak, Mustafa Duman, Elif Haykır Hobikoğlu, Emrah Şener, Yusuf Tuna.

The Monetary Policy Committee (MPC) has decided to reduce the policy rate (one-week repo auction rate) from 18 percent to 16 percent.

Despite the recovery in global economic activity in the first half of the year, recently published confidence indices have started to decline due to the effect of the pandemic. Nonetheless, despite the increase in the vaccination rate, new variants keep the downside risks to global economic activity alive. Recovery in global demand, high course of commodity prices, supply constraints in some sectors and rise in transportation costs have led to producer and consumer price increases internationally. Unfavorable effects of weather conditions in major agricultural commodity exporting countries are observed on global food prices. While the effects of high global inflation on inflation expectations and international financial markets are closely monitored, central banks in advanced economies assess that the rise in inflation would be mostly temporary along with normalization in demand composition, easing of supply constraints and waning base effects. Accordingly, central banks in advanced economies continue their supportive monetary stances and asset purchase programs.

Leading indicators show that domestic economic activity remains strong, with the help of robust external demand. The spread of domestic vaccination throughout the society facilitates the recovery in services, tourism and related sectors, which have been adversely affected by the pandemic, and leads to a more balanced composition in economic activity. While the demand for durable consumer goods slows down, a recovery is observed in non-durable consumer goods. The improvement in annualized current account is expected to continue in the rest of the year due to the strong upward trend in exports, and the strengthening of this trend is important for the price stability objective.

Recent increase in inflation has been driven by supply side factors such as rise in food and import prices, especially in energy, and supply constraints, increase in administered prices and demand developments due to the reopening. It is assessed that these effects are due to transitory factors. On the other hand, the decelerating impact of the monetary tightening on credit and domestic demand is being observed. The tightness in monetary stance has started to have a higher than envisaged contractionary effect on commercial loans. In addition, strengthened macroprudential policy framework has started to curb personal loan growth. The Committee evaluated the analyses to decompose the impact of demand factors that monetary policy can have an effect, core inflation developments and supply shocks. Accordingly the Committee decided to reduce the policy rate by 200 basis points to 16 percent. Nevertheless, the Committee assessed that, till the end of the year, supply-side transitory factors leave limited room for the downward adjustment to the policy rate.

In order to contain climate-based and other environmental risks, the Committee also decided to support sustainable finance initiatives as a long-term policy without prejudice to the main objectives of monetary policy.

The CBRT will continue to use decisively all available instruments until strong indicators point to a permanent fall in inflation and the medium-term 5 percent target is achieved in pursuit of the primary objective of price stability. Stability in the general price level will foster macroeconomic stability and financial stability through the fall in country risk premium, continuation of the reversal in currency substitution and the upward trend in foreign exchange reserves, and durable decline in financing costs. This would create a viable foundation for investment, production and employment to continue growing in a healthy and sustainable way.

The Committee will continue to take its decisions in a transparent, predictable and data-driven framework.

The summary of the Monetary Policy Committee Meeting will be released within five working days.

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