Surprise Interest Rates Rise in Turkey
To the surprise of us and almost everybody in the financial markets, the Central Bank (CB) raised its main policy interest rate by 175 bps to 15%. The average expectation for the rate increase in the market was around 50-75 bps, while we were not expecting anything more than 50bps.
In the accompanying short note, the CB said that the annual inflation shifted above the path that is compatible with the year-end inflation target of 5%, following very high inflation readings in April and May. The CB also acknowledged that the increases in the Forex rates due to the turmoil in the financial markets could temporarily push the annual inflation rates higher than its current levels.
Hence, the CB noted, they had decided to take a decisive step in order to prevent medium-to-long term inflation expectations to deteriorate even more, not to allow the turmoil in the financial markets to produce permanent adverse effects on pricing behavior, and to ensure that medium term inflation outlook remain on track with targets.
The CB noted that the probability of increasing the policy rate in the near future is less now when compared to May, adding that they might lower the rates when the medium term inflation targets seemed attainable. Hence, the CB opted for a once-and-for-all increase in the interest rates to stop speculations of any further rate hikes. They think that this bold move would calm down the markets and prove that the CB could take drastic measures independently when it is seen necessary.
Therefore, we think that the CB not only wanted to take a measure to ensure the attainability of medium-term inflation target, but also to give markets a signal that the relative independency of the CB that we had been enjoying in the last couple of years was still intact.
Nevertheless, we think that even this excessive rate hike would not help the CB to attain the 5% year-end inflation target. In fact, we think that even the CB does not believe in this to happen. What the CB wanted to do is to ensure that the inflation target of 4% set for 2007 could be achieved. Hence, we do not expect an instant turnaround in the inflation readings in the coming months and forecast that the annual inflation by the end of the year would be higher than the upper band.
However, the CB’s determination would help the markets to adjust their medium-to-long term inflation expectations according to the official targets; given that we would not have significant external shocks and the government would show the same determination as the CB.
SOURCE: Yapi Kredi Bank
