* Bank facing growing pressure to raise interest rates
* PM Erdogan warns against 'interest rate lobby'
* Central bank focused on forex-selling to support lira
By Seda Sezer
ISTANBUL, July 11 Turkey's central bank faced
calls on Thursday to raise interest rates to steady the
embattled lira despite political pressure from Prime Minister
Tayyip Erdogan to keep rates low - a dilemma which could put the
bank's credibility at stake.
The lira has tumbled some 9 percent against the dollar since
the beginning of May, leading to $3.55 billion sold off in two
days this week alone in its defence.
Investor concerns the U.S. Federal Reserve would scale back
stimulus measures and anti-government protests across Turkey
last month have driven the losses.
An overnight signal that U.S. money-printing may not end as
soon as expected has eased pressure on the lira for now but
Turkey remains most vulnerable to foreign capital outflows among
emerging markets as it combats a huge current account gap.
Last week alone, non-residents' holdings of Turkish
government domestic debt securities fell a net $553.9 million,
data showed on Thursday.
Investor concerns about the bank's room for manoeuvre have
risen since Erdogan, who has overseen a boom in the Turkish
economy during his 10 years in power, accused a 'high interest
rate lobby' of instigating unprecedented protests against his
government last month.
Without identifying the grouping any further, he accuses it
of manoeuvring to undermine the Turkish economy in order to curb
growing Turkish political and economic influence.
Such comments cast doubt on prospects for a rate hike,
although a sharp whittling down of net reserves, now estimated
by bankers to be below $40 billion, could set limits to the
forex auctioning policy pursued this week.
"The central bank's willingness to undertake such a rate
adjustment is unclear, in particular given the strong government
rhetoric against 'high interest rate lobbies'," said Christian
Keller, Barclays Capital economist.
"Ultimately, only a combination of continued pressure on the
lira and further forex reserve losses might force the central
bank to act," he said.
After a rebound in the lira overnight, the central bank held
just one forex-selling auction on Thursday, selling $50 million
at an average rate of 1.9414. However, the lira weakened again
Analysts said the central bank could not afford to allow the
lira depreciation to continue, while above-target inflation and
rapid consumer loan growth also argued against the current low
level of interest rates.
"The central bank cannot let the currency go as this could
potentially lead to an inflation/depreciation spiral, hurt the
bank's credibility dearly and have a detrimental impact on
corporate balance sheets," JPMorgan economist Yarkin Cebeci
"Instead, if the lira remains under pressure, hiking rates
would be a safer strategy for the central bank...We expect the
bank to hike the policy rate at most by 100 basis points as a
sharper increase could lead to increased political pressure and
its benefit would be doubtful," he said.
The central bank kept its main policy rate, the one-week
repo rate, at 4.50 percent, its borrowing rate at 3.5 percent
and lending rate at 6.5 percent at its last meeting on June 18.
Its next meeting is on July 23.
However the bank is more concerned about growth which slowed
sharply to 2.2 percent last year. It has undertaken a series of
rate cuts since last September to try to spur the economy until
last month, when it kept its rates on hold.
The bank is now focused on tightening liquidity to support
the lira, burning $3.55 billion in two days this week after the
lira hit an all-time low of 1.9737 against the dollar on Monday.
It has sold $6.2 billion this year.
Central Bank Governor Erdem Basci vowed the tightening would
be "strong, effective, temporary" and said it would only make a
change in the bank's interest rate corridor if the tightening
fails to prevent excessive loan growth.
APPROACH OF ELECTIONS
However the bank's reliance on forex-selling auctions to
support the lira has its limits.
"When autumn comes the central bank will have to change
interest rates. The gap between market rates and the central
bank interest rates widened so much. Benchmark bond yield rose
to 9.3 percent while the policy rate is at 4.5 percent," said
Mehmet Besimoglu, chief economist at Oyak Securities.
With elections looming next year, Erdogan will have to weigh
populist pressure in government to keep rates low with the need
to protect the gains of his decade in power which have
transformed Turkey economically and brought financial stability.
Erdogan has won three national elections in a row and
appears still to enjoy broad support across Turkey; but it is
not clear how June protests, and Erdogan's hardline
declarations, will be reflected in next year's local polls.
"The political authority would not favour a rate hike ahead
of an upcoming election period," Besimoglu said.
However, some market watchers said Erdogan's resistance to
raising rates could be eased by more pragmatic voices in
government such as Deputy Prime Minister Ali Babacan.
"At the end of the day Erdogan listens more to Babacan.
Erdogan has the final word but as long as Erdem Basci has the
support of Babacan we will see a quasi-independent central
bank," said a London-based fund manager who declined to be
"Erdogan may say no at first to rate rises but if Babacan
insists he will eventually agree," the fund manager said.
Another key figure in Erdogan's decision making will be
Finance Minister Mehmet Simsek, a former London banker, who
highlighted in comments on Twitter overnight the doubling in
Turkey's benchmark bond yield to 9.4 percent since May.
Blaming the sharp rise in yields on global economic
developments and the increasing risk premium due to last month's
protests, Simsek's comments underlined the government's concerns
about higher interest rates.
"If the rise in yields permanent, unfortunately, a bigger
portion of the taxes we collect will have to be allocated to
interest instead of services," he wrote.