EMERGING MARKETS-Turkish rate hike boost starts to fade, S.Africa faces pressure

LONDON Wed Jan 29, 2014 4:51am EST

LONDON Jan 29 (Reuters) - Turkey's lira posted its biggest one-day gain in more than five years on Wednesday after huge interest rate hikes, but the impact was already starting to fade, while South Africa now also faces pressure to tighten policy.

Turkish debt insurance costs slumped and its sovereign bond yield premia to U.S. Treasuries fell 20 basis points.

But the biggest immediate impact was on the lira, which rose more than 3 percent against the dollar after the central bank jacked up all of its interest rates late on Tuesday.

The currency relief also pushed up Turkish lira bonds, with 10-year yields dropping almost 40 basis points, but the lira eased off session highs of 2.16 per dollar to stand at 2.24 by 0921 GMT.

The central bank is trying to counter a massive lira selloff caused by the prospect of a reduction in U.S. stimulus that is sucking investor cash out of the most vulnerable emerging economies, where real interest rates were deemed too low to compensate for growing economic and political risks.

The hike follows similar moves across the developing world, with India unexpectedly raising interest rates this week, and Brazil and Indonesia already in policy-tightening mode.

But with the U.S. Federal Reserve expected to announce later in the day plans to shave another $10 billion off monthly bond buying, any emerging market rallies may be short-lived.

Ilan Solot, a strategist at Brown Brothers Harriman, said the lira moves were down to investors covering short positions against the dollar.

"The most a move like this can achieve is to bring emerging markets back a high-beta type of status, (meaning) it will perform in line with developed markets," Solot said.

"Before this, EM was underperforming. The idea, if this move gets traction in the market, after moves by Brazil, India and Turkey, you can take the edge off EM."

In Asia, currencies rallied with the Korean won posting its biggest gains in 6-1/2 months, but rallies in most emerging markets indeed faded. South Africa's rand gave up early gains to ease 1 percent to the dollar.

The policy pressure has moved to South Africa, where analysts expect interest rates to stay unchanged at 1300 GMT. Swap markets however are pricing a roughly quarter point rate hike, while 100 basis points in policy tightening is factored in for the next six months, banks' data shows.

South African bond markets have seen heavy outflows in recent sessions, with the benchmark yield having risen 30 bps since the start of this week.

"Although the (central bank) will be very reluctant to hike rates in such a weak growth environment, failure to do so risks South Africa getting left in the wake of other emerging markets that have been hiking aggressively," analysts at Tradition said in a note.

Others, however, point to South Africa's weak domestic demand and lower inflation compared to Turkey or India and reckon an interest rate rise is unlikely.

"The slowdown in Chinese demand and the fall in mining output because of strikes have been at the root of export weakness and the current account deficit. I am not sure (a rate hike) will solve South Africa's external problems," said Claire Dissaux, head of economics and strategy at Millennium Global.

But she added: "People have been focusing on the gap between emerging and U.S. rates and that's not high enough in many cases."

On equities, the main emerging index rose 1 percent off 4-1/2 month lows, with Turkish stocks up almost 2 percent on the currency relief. Greek stocks outperformed in emerging Europe with a 3 percent rise ATG>.

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