RPT-UPDATE 2-Turkey keeps rates on hold after emergency hike helps lira

Tue Feb 18, 2014 10:08am EST

* Turkey's main interest rates on hold as expected

* Lira recovered some losses since huge rate hike last month

* Lira, 10-year yield largely unchanged after decision

* Central bank says to keep policy tight to fight inflation

By Seda Sezer

ISTANBUL, Feb 18 (Reuters) - Turkey's central bank kept interest rates on hold on Tuesday after hiking them sharply last month to help stabilise the lira, shying away from further tightening for fear of hitting growth ahead of elections next month.

The bank kept its overnight lending rate at 12 percent, its one-week repo rate at 10 percent, and its overnight borrowing rate at 8 percent, as predicted by all 16 economists in a Reuters poll.

It said it would maintain its tight stance until there is a significant improvement in the outlook for inflation, which it expects to remain above its 5 percent target for some time.

"Having hiked interest rates in an extremely aggressive and somewhat panic-stricken manner last month, Turkey's central bank is taking a much-needed breather and is hoping its much stronger anti-inflationary stance will be enough to establish credibility," said Nicholas Spiro, head of London-based Spiro Sovereign Strategy.

"While a lot hinges on market sentiment towards emerging markets, concerns are already shifting from the current account deficit to the bleaker prospects for growth. The politics of Turkish monetary policy are taking centre stage," he said.

The bank stunned investors by hiking rates by some 500 basis points at an emergency meeting on Jan. 28, initially sending the lira sharply higher from record lows and helping short-circuit a vicious cycle of selling in emerging markets.

The move, which bolstered the bank's credibility in the eyes of investors, had been opposed by Prime Minister Tayyip Erdogan.

Bent on maintaining economic growth ahead of an election cycle starting with local polls next month, the prime minister has been a vocal opponent of higher borrowing costs.

TURBULENCE AHEAD

The bank had for months been struggling to defend the lira by burning through its currency reserves and trying to squeeze up borrowing costs on the margins without resorting to outright rate hikes, a battle it was clearly losing.

The lira was trading at 2.1810 against the dollar by 1234 GMT, largely unchanged from just before the rate decision. It remains comfortably off the record low of 2.39 hit on Jan. 27.

But economic storm clouds are gathering and the lira could come under renewed pressure in the coming months, with a potentially turbulent election period ahead and Turkey's huge trade shortfall leaving it one of the most vulnerable emerging markets to the winding back of U.S. monetary stimulus.

Data last week showed the current account deficit widened more sharply than thought in December, with the gap for 2013 expected to reach around 8 percent of GDP.

The central bank's survey of businessmen and economists meanwhile showed inflation expectations continue to deteriorate, with CPI seen rising 7.92 percent at year-end, well above its own forecast of 6.6 percent.

"This alone will likely to prevent central bank from tuning down its hawkish bias anytime soon," said Erkin Isik, a strategist at TEB-BNP Paribas.

The main Istanbul share index fell 0.51 percent to 65,261.89 points, underperforming the wider emerging markets index .MSCIEF, which fell 0.20 percent.

The yield on the 10-year benchmark bond was little changed at 10.25 percent from 10.24 percent on Monday.