Turkey CB Facing Interest Rate Dilemma

Turkey’s central bank faces a major credibility test when it meets on Tuesday, with investors hoping for a significant interest rate hike after attempts to defend the lira with liquidity measures proved ineffective.

President Tayyip Erdogan, long a fierce critic of high borrowing costs, has been less vocal in recent days on central bank policy, raising hope in financial markets that the bank will be able to act decisively and shore up the currency, AMEinfo reported.

Fifteen out of 18 economists polled by Reuters expect the central bank to increase its benchmark repo rate, with nine of them forecasting an increase of 50 basis points. But it may take a lot more to put a floor under the lira—UBS, a financial services company, said recently that increases of 200 basis points may be needed to anchor the currency in the next month or two.

“The market wants to see the one main message, and that is that the central bank remains independent,” said Simon Quijano-Evans, emerging markets strategist at Legal & General Investment Management.

The lira has lost some 8% already this year—on top of double-digit percentage declines both last year and in 2015—underscoring concerns about the economy and central bank independence. Erdogan has characterized the sell-off as an attack on the economy by outside forces.

Investors, like some of Turkey’s western allies, say they have been unnerved by the crackdown that followed a failed coup in July. But their biggest concern appears to be Erdogan’s stance on monetary policy. The president, an economic populist, has declared himself an “enemy” of interest rates, saying he wants cheap credit to spur the economy.

Market participants say the central bank needs to make aggressive rate increases to clearly show the markets it is independent. Erdogan has said the bank is independent but he is free to criticize it.

As the lira slides, central bank Governor Murat Cetinkaya has fought back with unorthodox moves that have done little to stem the sell-off or arrest concerns about the central bank’s independence.

Market participants have referred to the measures as “covert tightening”, an attempt to mop up liquidity and defend the lira without an outright rate hike. Such efforts only underscore concerns that the bank is reluctant to act decisively, market participants say.