UPDATE 3-Turkish central bank cuts rates to fuel growth, deter hot money

Tue Apr 16, 2013 10:23am EDT

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By Seda Sezer

ISTANBUL, April 16 (Reuters) - Turkey's central bank cut its three main interest rates more deeply than expected on Tuesday in a bid to stimulate growth and guard against hot money fuelling a sharp rise in the lira, sending benchmark bond yields to a record low.

Turkish economic growth slowed sharply to 2.2 percent last year and the central bank has been trying to spur the economy since mid-2012, embarking on a series of rate cuts last September. Domestic demand remains weak, although bank lending is rising faster than the central bank wants.

It has also been taking steps to battle a flood of cheap cash from central banks in the developed world that threatens to knock the Turkish economy off balance, a prospect made all the more real after the Bank of Japan announced an unprecedented $1.4 trillion stimulus package this month.

The central bank cut each of its main rates by 50 basis points, lowering its one-week repo policy rate to 5.0 percent, its overnight borrowing rate to 4.0 percent and its overnight lending rate to 7.0 percent.

"Post-Japan, the policy stance is once again geared towards managing accelerating capital inflows," Finansbank chief economist Inan Demir said in a research note.

In a statement following its decision, the central bank said that capital inflows had recently accelerated anew and noted that domestic loan growth remained higher than it would like.

"In order to balance risks to financial stability, the committee deemed it appropriate to maintain macro-prudential measures ... by keeping interest rates low while increasing forex reserves," it said.

It raised the amount of forex that lenders have to provide to hold a portion of their required reserves in foreign exchange, a move which will boost its own forex reserves while tightening lenders' forex liquidity.

The yield on Turkey's two-year benchmark bond sank to a record low below 5.50 percent after the decision, from 5.68 percent earlier. It inched back up to 5.58 percent by 1404 GMT.

The lira firmed to 1.7915 against the U.S. dollar from 1.7960 before the decision.

GROWTH BACK IN FOCUS

Economy Minister Zafer Caglayan, who has repeatedly criticised the central bank for doing too little to fuel growth, said the move was long overdue and forecast further rate cuts.

"This step is as late as it is correct. (The central bank) could and should have created this environment in 2012 before domestic demand became this weak. The brakes were hit too hard," he said in a statement following the decision.

Central Bank Governor Erdem Basci had hinted at a cut, saying early this month the bank may consider lowering its main rate if the lira climbed too fast, which could widen the current account deficit, Turkey's main economic weakness.

"It was quite a bold move. They want to clearly make a point on their commitment to maintain the currency stable and to prevent appreciation," said Gaelle Blanchard, emerging markets strategist at Societe Generale.

A stronger lira makes exports more expensive and imports cheaper, which can widen the current account gap and put Turkey deeper into debt to external markets. The gap is expected to grow to over $58 billion this year from $47 billion in 2012.

In a complicated policy mix, the central bank has been trying to stimulate overall economic growth while trying to prevent domestic credit growth from spiralling out of control and causing the economy to overheat.

Last month, it unexpectedly slashed its overnight lending rate but moved to tighten liquidity overall by reducing lira funding and draining more foreign currency and gold from the market.

Economists said its latest decision suggested concerns about growth and hot money had returned to the fore.

"By this move, the central bank is saying that it is a bit more worried about the outlook for growth than ... last time around, when the message seemed relatively hawkish," said Standard Bank economist Timothy Ash.

"The central bank is still banging the drum that lower rates are needed to stem hot money inflows, and hence appreciation pressure on the lira (which is) bad for the current account deficit and growth," he said.

Ten out of 12 economists in a Reuters poll had expected the bank to cut the benchmark rate this month. Eight of the 10 predicted a 25 basis point cut and two forecast a 50 point cut.

The bank last cut its policy rate in December, when it trimmed the rate by 25 basis points. Before that, the previous cut was in August 2011, again a 25 basis point reduction. (Additional reporting by Daren Butler and Ayla Jean Yackley; Writing by Nick Tattersall; Editing by Hugh Lawson)

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