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Wednesday, September 19, 2007

CBRT Lowers Interest Rates

The CBRT decided last week to lower Turkish interest rates, reducing the overnight borrowing rate from 17.50 to 17.25 percent,. According to the press release:
Readings on economic activity and inflation are in line with the outlook presented in the July Inflation Report. While private consumption and investment demand exhibits signs of recovery, external demand moderates. Aggregate demand conditions continue to support the disinflation process. The Committee assesses that developments in services inflation have been more favorable than expected. Notwithstanding the risks related to energy and food prices, inflation is expected to further decelerate owing to the lagged effects of strong monetary tightening.

The Committee closely monitors the developments in international liquidity conditions and credit markets. In the meeting, the Committee evaluated the recent data, and assessed that global developments are likely to restrain both the domestic and external demand growth, increasing the downward risks on achieving the 4 percent target in the medium term.

In this respect, the Committee decided that current conditions require launchingthe measured rate cuts mentioned in the Inflation Report. The Committee underlines that the current monetary policy stance continues to be restrictive. The exact timing and extent of further easing may vary depending on the incoming information regarding global liquidity conditions, external demand, public expenditures and other determinants of medium term inflation outlook.

Serhan Cevik comments:

With an unexpected decision, the Central Bank of Turkey lowered interest rates by 25bp to 17.25% last week. What is surprising about the start of the monetary easing campaign is its timing. After all, the central bank over-tightened the policy stance by 425bp to 17.5% last summer in an attempt to rebuild credibility and rein in the inflationary impact of the lira’s sudden depreciation. As expected, maintaining such an ultra-tight monetary policy stance for more than a year has moderated growth in domestic demand, helped in strengthening the exchange rate and gradually improved inflation dynamics. This is why we have long argued for the coming normalisation of interest rates, expecting a gradual easing cycle towards 16.5-16.75% by the end of this year and around 14.5-15% in 2008. However, with the recent volatility in global financial markets and the rise in energy and food prices, we revised our expectation for the start of monetary easing from a 25bp reduction in September to a 50bp cut in October (or even possibly November). We thought that a higher degree of global uncertainty warranted a more cautious approach, even though slower growth in the world economy may well have disinflationary effects over the medium term (see The Case of Gradualism, August 6, 2007). Obviously, the central bank thought otherwise and moved ahead with the first rate cut. Could this lead to a dislocation, especially since we were calling for a rate cut next month? The problem is not whether domestic factors justify the easing, but the emergence of new risks along with higher energy and food prices.

Actually, if we look at what is happening to the Lira this morning, following the Federal Reserve decision yesterday, then we can think of another interpretation for this decision, and that is to reduce the speculative inflow of funds during the uncertainty and volatility which is surely going to follow the lowering of the federal funds rate:

Turkey's lira gained by the most in almost two months against the dollar as the Federal Reserve decision to cut interest rates spurred investors' appetite for riskier, emerging-market assets.

The lira, the best performer in the past month, rose with other emerging-market currencies such as Iceland's krona and Hungary's forint after the Fed cut its benchmark rate to 4.75 percent, pushing global equity markets higher. Turkey's ISE National 100 Index advanced 3.5 percent.

Obviously the argument about a lowering in US interest rates increasing the appetite for riskier assets doesn't make any sense at all, since it seems to imply that a US recession may be on the way, and this would normal produce a safe haven mentality. The point is, where will the safe havens be this time round? One of my arguments here on this blog is that in fact Turkey - despite its exposure to a slowdown in Europe - may well be able to weather the storm better than others, although I am not at all convinced that financial market participants can see this at this point. Evidence for that might be the fact they are buying the Hungarian forint too, and that is a very different story indeed.

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