UPDATE 2-Turkey cuts main interest rate, resists pressure for sharp move

Tue Jun 24, 2014 8:31am EDT

Related Topics

* Market consensus was for a 50 basis point cut

* Lira, bond yields stable after the decision

* Bank credibility seen in the balance (Adds analyst comment, details)

By Seda Sezer

ISTANBUL, June 24 (Reuters) - Turkey's central bank cut its main interest rate slightly more than expected on Tuesday, but stopped short of jeopardising its credibility with the sort of deeper move sought by Prime Minister Tayyip Erdogan ahead of an August election.

The bank cut its main one-week repo rate by 75 basis points to 8.75 percent, saying inflation was expected to start falling significantly from this month and that global liquidity conditions had recently improved.

Erdogan, determined to maintain growth ahead of the August presidential election and parliamentary polls next year, has been a frequent critic of central bank policy and has repeatedly made populist calls for lower interest rates.

The lira firmed to 2.1280 from 2.1320 against the dollar immediately after the decision, apparently on relief that the bank had not yielded to political pressure and cut rates more sharply. It later eased back to trade broadly flat.

"This move is slightly more dovish than what the market anticipated, but the market is taking the view that the central bank has earned some credibility and inflation is indeed on its way down," said Manik Narain, a strategist at UBS in London.

The market had been pricing in a moderate cut after Central Bank Governor Erdem Basci said last week the bank could lower rates if the inflation outlook was improving significantly.

But annual inflation stood at 9.66 percent in May, well above the central bank's year-end forecast for 7.6 percent and its 5 percent medium-term target. The bank has repeatedly said it expects inflation to start falling from June.

"The (central bank) is trying to balance the need to maintain credibility in the markets on the one hand and government pressure to lower interest rates substantially on the other," William Jackson, an economist at Capital Economics in London, said in a note to clients.

"The larger the size of the easing cycle, the greater the risk that the (bank) will damage its own credibility and the more vulnerable the economy will become to a shock that causes investors to pull back ... The conditions aren't in place for a marked and sustainable reduction in interest rates," he said.

Economists had said that looser monetary policy from the European Central Bank, an expected deceleration in Turkish inflation in the coming months and declining bond yields would prompt the central bank to make a measured rate cut.

Some analysts said too sharp a move could undermine the lira, which has already been underperforming its emerging market peers since the recent Islamist insurgency sweeping neighbouring Iraq, Turkey's second-biggest export market.

All 20 economists in a Reuters poll forecast a cut in the one-week repo rate, with 16 predicting a 50 basis point cut, three a 75 basis point cut, and one a 25 basis point cut.

The bank kept its overnight lending rate at 12 percent and its overnight borrowing rate at 8 percent, giving it the flexibility to adjust banks' funding costs as needed.

BACK TO JANUARY LEVELS

Last month the central bank cut its one-week repo rate by 50 basis points, its first cut in a year. Erdogan belittled the move as not enough to unwind its sharp hike in January, when it raised the rate by 550 basis points.

"Are you kidding? When you raise (interest rates) you do it by 5 percentage points at once, when you cut, only half a percentage point," he was quoted as saying a few days later.

His economy minister, Nihat Zeybekci, said on Monday the central bank should bring interest rates back at least to where they were before late January, when the one-week repo rate stood at 4.5 percent, although he acknowledged he did not expect this to happen immediately.

The comments unnerved investors.

"It was already patently clear last month that Turkey's central bank was keen to reverse January's dramatic rate hikes at the cost of undermining its inflation-fighting credentials," said Nicholas Spiro, head of Spiro Sovereign Strategy in London.

"The more the central bank loosens monetary policy, the more this reinforces the perception that it is succumbing to political pressure," he told Reuters.

Deputy Prime Ministers Bulent Arinc and Ali Babacan, and others including Finance Minister Mehmet Simsek, have played down concerns about political interference, saying the government fully understands the need for an independent central bank and does not interfere in monetary policy.

But Erdogan, who is widely expected to contest and win the August presidential election, has frequently railed against an "interest rate lobby" of speculators he sees as trying to drive up rates at the expense of the Turkish economy.

"It's difficult to predict how much further the central bank will reduce interest rates from here on," said Jackson.

"But given the increasingly aggressive rhetoric from the government and the fact that the markets are allowing the MPC to lower rates - there was no market reaction to today's move - the easing cycle could be significant." (Additional reporting by Nevzat Devranoglu and Daren Butler in Istanbul, Sujata Rao in London; Writing by Nick Tattersall; editing by Ralph Boulton)

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