Turkey Monetary Policy Update

Having pursued an aggressive easing policy since the start of 2016, the Central Bank of Turkey has now reversed course, with the monetary policy committee raising interest rates for the first time since 2014 on 24 November. While the overnight borrowing rate was kept at 7.25%, the marginal funding rate was raised 25bps to 8.50%, and the one-week repo rate increased 50bps to 8.00%. Before the meeting the CBT had cut rates by a cumulative 250bps this year as authorities attempted to stimulate growth amidst widespread signs of an economic slowdown. In a separate press release, the bank also noted that FX reserve requirement ratios were cut by 50bps, which it expects will add USD1.5bn in additional liquidity to the financial system.

The rate hike comes amidst ongoing signs of slowing inflation and weak economic activity. Indeed, core inflation dropped to its lowest level in over three years in October at 7.0% y/y. Although the CBT’s press release noted that it expected growth to begin recovering in Q4, so far there is little evidence of a turnaround, with high-frequency indicators such as retail sales, PMIs and industrial production all pointing to a sharp deceleration in the latter months of the year. Rather, the bank noted ‘exchange rate movements due to recently heightened global uncertainty and volatility pose upside risks on the inflation outlook’.

Clearly, the rate hike was on account of concerns over the trajectory of the Turkish lira, which continues to post new all-time lows. The lira has been one of the weakest performing emerging market currencies against the USD this year, with only the Argentine and Mexican pesos faring worse. Global monetary conditions have certainly become less supportive in recent weeks as markets increasingly price-in the likelihood of a Fed rate hike in December and the potential for fiscal stimulus alongside a Donald Trump presidency in 2017. While the CBT will be eager to reverse course and begin easing policy as quickly as possible, they will be constrained by the stability of the lira in the near term.

Domestic factors have also played a role in the lira’s slide, particularly ongoing uncertainty surrounding the direction of policymaking. In what is a highly symbolic move, on 24 November the European Parliament called a non-binding vote in favor of a halt to EU membership talks with Turkey. The decision may not have short-term economic implications, however it does come to symbolize the disruption to the country’s convergence process that had been firmly anchored by EU-accession talks over the past decade.

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