* Central bank signals current policy will continue
* Reluctance to raise main rate has unnerved markets
* Bank raises inflation forecast for this year
* GRAPHIC: Tourism in Turkey: tmsnrt.rs/2aMNSxo (Adds quotes, market reaction, tourism data)
By Ece Toksabay and Nevzat Devranoglu
ANKARA, Jan 31 (Reuters) - Turkey’s central bank signalled on Tuesday it would stick with its unorthodox steps to manage the fall in the lira, saying its moves to drive up funding costs were working and would continue until the inflation outlook improves.
The lira has fallen more than 7 percent this month after double-digit declines in both 2015 and 2016, making it one of the world’s worst-performing currencies, while the economy shrank in the third quarter for the first time in seven years.
Investors have been unnerved by insecurity, political uncertainty and a slowing economy. But they also worry the central bank is under political pressure to avoid taking decisive action to support the lira and tame inflation.
The central bank raised its main policy rate - the one-week repo rate - on Nov. 25 for the first time since 2014 but it has remained unchanged since and President Tayyip Erdogan has made it clear he wants borrowing costs to stay low to boost growth.
Instead, the bank has stopped holding one-week repos, closing off its main channel for funding the market, and raised overnight and last resort borrowing rates, pushing funding costs for banks higher without having to change the benchmark rate.
“We will continue to use these steps as long as necessary. It should be expected for this framework to continue for a certain time,” central bank Governor Murat Cetinkaya said.
“If no permanent and serious improvements are seen regarding inflation expectations in the foreseeable future, it seems tightening will continue,” he told a news conference to announce the bank’s quarterly assessment of the inflation outlook.
With the lira continuing to weaken, the bank raised its inflation forecast for the end of 2017 to 8.0 percent from 6.5 percent in its previous report. Its forecast for inflation at the end of 2018 stands at 6 percent.
“Risks are upward, but the critical point is that monetary policy is having the necessary effect,” Cetinkaya said, adding that the bank might take additional measures if needed and would use all available tools.
Data published on Tuesday also showed the number of tourists visiting Turkey slumped by nearly a third in 2016 following a spate of bombings and a failed coup, a significant hit for a key sector in the economy.
Tourism accounts for 4-5 percent of gross domestic product and financed some 45 percent of Turkey’s current account deficit in the first 11 months of 2016, according to central bank data.
COMPLICATED POLICY MIX
Pressure from the government to keep borrowing costs low is unlikely to relent ahead of an expected referendum in April on constitutional changes which would create a full presidential system and hand Erdogan greater powers.
Still, the central bank’s efforts to tighten liquidity have raised short-term funding costs to their highest in nearly five years, helping support the lira even without the outright rate increase many in the market have been hoping for.
The bank has said it is aiming, over time, to provide funding via a single rate, rather than the multiple rates it is using now. Cetinkaya said that was still the aim but it would only make the shift when conditions were suitable.
“Simplification will be our preference once the right framework is set up and volatility has died down,” he said.
The currency firmed more than 2 percent on Monday, although it pared some of those gains as Cetinkaya spoke and was unchanged at 3.78 to the dollar by 1245 GMT. It hit a record low of 3.9417 on Jan. 11.
“The central bank governor sounded quite comfortable about the current monetary policy framework and it is good to hear tight monetary policy will prevail in the period ahead,” said Deniz Invest chief economist Ozlem Derici.
“However ... simplification seems to be off the agenda in the foreseeable future. This might deter the impact of tightening as we think that the current unorthodox policy mix employed complicates making forecasts,” she said in a note.
Besides worrying about a perceived lack of independence, investors are also concerned that the very short-term levers being used by the central bank now make it had to assess the actual impact of monetary policy.
Economic growth in 2016 is expected to have been just 3.2 percent, a far cry from the high single-digit rates on which Erdogan built his reputation as prime minister from 2003-14.
Officials have also said inflation is expected to reach double digits in the first quarter for the first time in almost five years, partly due to the weaker lira.
Ratings agency Fitch downgraded Turkey’s sovereign debt to “junk” on Friday, snuffing out its last remaining investment grade, hours after rival agency Standard & Poor’s lowered its outlook to “negative” from “stable”.
Both sounded concern about political insecurity after a failed coup last year, as well as pressure on the central bank.
Cetinkaya described S&P’s report as hurried, and dismissed concern about the bank’s independence, saying its future steps would bring an end to such discussions.