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Turkish central bank hikes lending rate, but leaves policy rate on hold

Turkey’s central bank on Tuesday hiked its overnight lending rate by 75 basis points after a slide in the lira but left its main policy rate on hold, steps that may not be sharp enough to draw a line under concern about its independence.

The decision had been seen as a critical test of the bank’s credibility. Investors were hoping for a significant rate hike to stem the lira’s falls, despite President Tayyip Erdogan’s vocal aversion to high borrowing costs.

The bank raised its overnight lending rate to 9.25 percent from 8.5 percent. All but one of 18 economists in a Reuters poll had forecast a hike in the overnight lending rate, which is the upper band of the bank’s interest rate corridor.

It left its benchmark one-week repo rate at 8 percent. Half of the economists had forecast a hike of 50 basis points.

The lira weakened as far as 3.8299 to the dollar after the announcement.

“It hasn’t quite convinced the markets … My sense is that further interest rate hikes are likely in the coming months,” said William Jackson of Capital Economics in London.

The bank increased the rate at its late liquidity window, where it has been increasingly encouraging lenders to source lira, to 11 percent from 10 percent. Economists had largely expected an increase, with estimates ranging between a hike of 50-300 bps.

“Inflation expectations, pricing behaviour and other factors affecting inflation will be closely monitored and, if needed, further monetary tightening will be delivered,” the bank said in a statement.

“Moreover, necessary liquidity measures will be taken in case of unhealthy pricing behaviour in the foreign exchange market that cannot be justified by economic fundamentals.”

The lira has fallen some 8 percent this year, adding to double-digit declines in 2015 and 2016. Investors have been unnerved by insecurity, political uncertainty and a slowing economy, and worry the central bank is less than independent.

Erdogan, who wants cheap credit to boost growth, has long been opposed to high interest rates and has characterised the lira sell-off as an attack on the economy by outside forces plotting to slow Turkey’s economy.

He and government officials have repeatedly insisted the central bank is independent. But the bank has resorted to unorthodox liquidity moves to try to defend the currency, heightening the perception it wanted to avoid a sharp rate hike.

It 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. Market participants have referred to such moves, which have largely been ineffective in recent weeks, as “covert tightening”.

The bank on Tuesday also left its overnight borrowing rate, the lower end of its interest rate corridor, at 7.25 percent.