Complex Made Simple

Will Turkey central bank increase interest rates to help lira?

* 15 of 18 economists see rate hike on Tuesday

* Some analysts say hefty hikes needed to stop lira slide

* Concerns about central bank’s independence persist

* Central bank has used unorthodox liquidity tools

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 currency 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.

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 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 percent 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 characterised 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 criticise it.

“The bank’s independence will be greatly questioned” if it fails to act decisively on Tuesday, said Fatih Keresteci of DNG Consultancy in Istanbul. That could see the lira tumble further, to 4 to the dollar, in “no time”, Keresteci added.

A dollar bought 3.8214 lira in afternoon trade on Friday.

Covert tightening

As the lira slides, 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.

“This system should definitely be turned into concrete monetary policy steps on Jan. 24. The central bank is supposed to be ‘a lifeline in the fog’ for markets, not a contributor to the fog,” said Ugur Gurses, a former central banker and a columnist for the mass-circulation Hurriyet newspaper.

The central bank has cut off some funding taps to force lenders to borrow from its costlier “late liquidity window”, a facility designed for banks who need a lender of last resort.

Bankers have traditionally equated use of the window with a loss of a prestige, seeing it as the last refuge for desperate borrowers, said one liquidity manager. Now, it has become a fact of life for banks, he said.

But because the “late” window is only available after 4:00 p.m., banks are forced to carry out some business – such as customer payments or money transfers – later in the day, causing problems for the sector, said Gurses, the former central banker.

Whether that will change depends on what the central bank does on Tuesday. For now, though, investors remain sceptical.

“There are times when market concerns are justified. We have been out of Turkey a long time,” Michael Hasenstab, the high-profile bond investor, told Reuters in a interview earlier this month.

“If you have a country going backward in macro policy and there is a slowdown in global trade, you can have a problematic environment and I would put Turkey in that category.”