(Bloomberg) — Turkey left its policy interest rates unchanged on Thursday, risking greater volatility in the lira as the central bank looks for a backdoor way of containing the currency’s weakness.
The Monetary Policy Committee held its key at 8.25% for a third month, in line with the majority of forecasts in a Bloomberg survey. In the view of most analysts, however, pressure on the lira and the worsening inflation outlook warranted an outright rate hike.
The MPC said it will continue with its “liquidity measures,” according to a statement. The Turkish lira depreciated after the decision, reversing earlier gains against the dollar.
“The gradual normalization of pandemic-specific financial measures and recent tightening steps taken in liquidity management are judged to support macrofinancial stability,” it said. “However, depending on the course of the pandemic, uncertainties regarding domestic and external demand conditions remain significant.”
Policy makers led by Governor Murat Uysal haven’t stood pat but instead tightened liquidity by relying on fringe tools and ceasing to provide funding at its cheapest benchmark rate. News on Wednesday of a possible energy discovery in the Black Sea may have also emboldened the central bank as Turkish stocks and the currency rallied.
Uysal’s preferred path will likely be to continue tightening by stealth and avoiding a change in the benchmark that could irk President Recep Tayyip Erdogan. The Turkish leader is a firm believer that high rates cause inflation. Most economists and central banks around the world believe the opposite to be true.
It’s a view Erdogan repeated this month even after the lira weakened to a record low. The currency is the third-worst performer in emerging markets this year with a loss of about 19% against the dollar.
The traded 0.9% weaker at 7.35 per dollar as of 2:20 p.m. in Istanbul, the biggest depreciation among the currencies of developing developing nations on Thursday. Yields on two-year local bonds added seven basis points to 13.33%.
“The resistance to hiking interest rates despite market forces suggesting otherwise shouldn’t come as a shock to anyone,” said Simon Harvey, a London-based market analyst at Monex Europe Ltd. “Whether this was the right decision by Governor Uysal, only time will tell.”
Investors anticipate the Turkish currency will remain among the world’s most unstable, with its three-month implied volatility the world’s second highest after Brazil’s real.
The central bank’s approach is now effectively to tweak the cost of funding on a daily basis, modifying the amount of liquidity available to lenders across its various rates. The average cost of cash provided by the central bank rose to 9.37% on Wednesday as a result, compared with as low as 7.34% in July.
It’s also conducted conventional repo auctions in which lenders set their own rates through bids, and limited the amount of money lenders can borrow in the interbank market, a move that may send some of them to seek funding at the regulator’s highest rate.
The monetary authority still has space for additional liquidity steps and could direct banks to borrow from its late liquidity window at 11.25%, Ibrahim Aksoy, chief economist and strategist of HSBC Asset Management Turkey, said before the decision.
Investors say the problem is that such an approach lacks transparency. What looks like tightening today can be reversed tomorrow with little notice or explanation.
It additionally amounts to a reversal of a decision under former Governor Murat Cetinkaya to focus on a single benchmark from June 2018 after a bout of lira depreciation resulted in a massive rate hike.
Prior to Thursday’s decision, Turkish policy makers delivered 1,575 basis points of rate cuts in nine consecutive steps before pausing for two months.
“They learned nothing from 2018, or it was just re-affirmed that Erdogan still runs monetary policy,” said Timothy Ash, a London-based strategist at BlueBay Asset Management. “We have seen the movie, got the t-shirt, eaten the popcorn.”
(Updates with analyst comment in ninth paragraph)
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