No one knows what Turkey's central bank will do tomorrow

When Turkey's inflation rate surged to a 15 year-high of 18 per cent earlier this month, the country's central bank vowed to take action at its next rate-setting meeting. That meeting is tomorrow, and analysts don't have a clue what the bank will do.

RBC Capital Markets put together the following chart tracking analysts' expectations for Turkey's one-week repo rate. While the median forecast calls for a 325bp increase to 21 per cent, there's no clustering around that level.

Some believe Turkey could walk back its signals from last week and continue to buck economic orthodoxy by keeping its benchmark rate at 17.75 per cent. Others believe the central bank will go big and announce a 725bp hike, to a rate of 25 per cent:

The average forecast of a 345bp increase tops the median, so as RBC's Adam Cole point outs, there's a skew to the upside. That's to be expected, he says: “the lesson of history is that CBRT builds expectations and then underdelivers.”

When Turkey's central bank held off from raising interest rates in July, the lira slid dramatically against the dollar: the currency has lost roughly 40 per cent of its value this year. Given the substantial amount of dollar-denominated debt held on Turkish balance sheets, a devaluation of this magnitude makes repayment all the more expensive, so the central bank might hike rates this time around to stabilise the lira.

To see that motivation in graphic form, here's a chart from Brad Setser at the Council on Foreign Relations showing just how exposed private banks and corporates are to the currency's fluctuations:

On the flip side, higher local borrowing costs, which we have argued are economically unnecessary at this point, put an additional strain on Turkish consumers and corporates when the economy is already adjusting quickly.

While GDP is growing at a fast clip of 5.2 per cent year-on-year, it's slower than the 7.4 per cent pace last year. Plus, the central bank has already moved to increase rates via a backdoor. In July, it raised the overnight lending rate to 19.25 per cent, 150bps above the one-week repo rate.

Much of the confusion about what Turkey's central bank will do stems from uncertainty about how much grip President Recep Tayyip Erdogan has on determining monetary policy.

Considering Erdogan just appointed himself the chairman of the country's $50bn sovereign wealth fund, and appointed his son-in-law turned Finance Minister as deputy, it would not be a complete surprise if the self-avowed “enemy of interest rates” prevails.

Related Links:
Turkey's central bank under pressure to raise rates - FT
Turkey's economy doesn't need higher interest rates - FT Alphaville
Turkey's corporates need the “the mother and father of all evil” - FT Alphaville

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