UPDATE 2-Turkey surprises with rate cut weeks after Erdogan's call

Thu May 22, 2014 9:37am EDT

* First rate cut for a year comes weeks after Erdogan call

* ECB, Fed policy stance gave room for manoeuvre

* Inflation remains stubbornly high

* Two-year bond yields drops to lowest in 6 months (Adds comment, details)

By Seda Sezer

ISTANBUL, May 22 (Reuters) - Turkey's central bank surprised markets with its first rate cut in a year on Thursday, weeks after Prime Minister Tayyip Erdogan called for rates to fall - reviving questions about political pressure on the bank.

The bank said "decreasing uncertainty" and an improvement in risk-premium indicators prompted the 50-basis-point cut in its one-week repo rate to 9.5 percent. Yields on Turkey's two-year bond slid to a six-month low after the announcement.

Economists said expectations that the European Central Bank would loosen policy and that the U.S. Federal Reserve would not raise rates anytime soon had given Turkey room for manoeuvre. The cheap global liquidity that has helped it finance its current account deficit looks set to continue for some time.

But the timing of the rate cut, after inflation rose more than expected in April, caught many by surprise. Analysts had expected a reduction only after headline inflation started ticking lower in the second half of the year.

Only two of 13 economists in a Reuters poll had forecast a cut this month. The bank kept its overnight lending rate at 12 percent and overnight borrowing rate at 8 percent.

"This was a politically driven rate cut, facilitated by the marked improvement in sentiment towards Turkish and emerging- market assets over the past few months," said Nicholas Spiro, head of Spiro Sovereign Strategy in London.

"Today's rate cut looks and feels like the start of a slippery slope for a central bank still struggling to conduct a credible and transparent monetary policy and at a time when sentiment towards emerging markets still remains fragile."

Erdogan, anxious to maintain a record of strong economic growth before his expected bid in August's presidential election, called last month for a rate cut. The victory of his ruling party in local elections, he said, had reduced political uncertainty and such a move would reassure investors.

Erdogan has long been a strident opponent of high borrowing costs, accusing an "interest rate lobby" of foreign investors and speculators of conspiring to drive up rates at the expense of Turkey's economic health.

He has had a difficult year, with anti-government protests last summer, a corruption scandal dogging his inner circle in December, and a mine disaster last week drawing renewed criticism of his leadership. The last thing he needs as the presidential election approaches is a marked economic slowdown.

Central Bank Governor Erdem Basci appeared to have been resisting any such pressure, saying politicians had a right to their views but insisting that the central bank had a free hand.

He said last month he saw room for a gradual lowering in rates but ruled out a deep cycle of easing. Policy would stay tight until there was a clear improvement in the inflation outlook, he said.

OLD TRICKS

"With the recent decline in uncertainties and improvement in the risk premium indicators, market interest rates have fallen across all maturities," the bank said in a statement after its monetary policy committee meeting.

The lira was little changed after the decision, hovering around 2.09 to the dollar. Turkey's 2-year benchmark bond yield fell to 8.83 percent, its lowest since Nov. 20 last year, from 9.10 percent at Thursday's close.

Analysts had expected rate cuts further ahead once headline inflation started coming down, forecasting it would start to fall from mid-year. Inflation rose to a higher-than-expected 9.38 percent year-on-year in April.

The central bank also expects inflation to begin falling in June but still sees it at an above-target 7.6 percent at year end. The bank has repeatedly said it will keep monetary policy tight until the inflation outlook improves significantly, a message it repeated on Thursday.

"It's giving a signal to Ankara that it cut rates by slashing the one-week repo rate 50 basis points, but overnight market interest rates hover around 11 percent," said Ugur Gurses, a former central banker and newspaper columnist.

"The central bank is going back to its old self, giving one signal to Ankara and another to the market," he told Reuters.

The bank raised rates sharply at the end of January to combat a fall in the lira to record lows. It had already been reducing average borrowing costs without resorting to rate cuts, by providing more funding to the market through its one-week repo auctions. Those carry a fixed simple rate of 10 percent, rather than the 12 percent marginal lending rate.

The average cost of borrowing had fallen to around 10.0 percent as a result, from levels of around 10.2-10.3 percent in late March.

(Additional reporting by Asli Kandemir and Dasha Afanasieva; Writing by Nick Tattersall; Editing by Ralph Boulton, Larry King)

Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.