Azernews.Az

By Bloomberg

Speculation that Turkey’s central bank will cut its three main interest rates for the first time in 22 months isn’t winning plaudits from the bond market.

Economists say Governor Erdem Basci will lower the benchmark repurchase rate, and the overnight lending and borrowing rates when policy makers convene on Tuesday. Two-year yields jumped the day before the meeting, extending the biggest bond selloff in emerging markets over the past month. Yields have risen amid mounting concern that criticism of the central bank by President Recep Tayyip Erdogan is influencing policy.

Erdogan kept up the pressure even as policy makers lowered the benchmark by 50 basis points to 7.75 percent last month, saying they were cutting too slowly and “cheating” the nation by keeping the overnight rate, which banks use for calculating the cost of credit, unchanged. Basci has countered by saying the key determinant is inflation expectations, which have been falling amid the eight-month plunge in oil.

If the comments continue, “the worst-case scenario of a full-blown conflict between the central bank and Erdogan could unfold in coming months,” Piotr Matys, an emerging-market strategist at Rabobank International in London, said Feb. 23 by e-mail. That “would have negative implications for Turkish assets,” he said

Governor Basci has been under persistent attack from Erdogan and his allies since the bank more than doubled its main rate in January last year to bolster the lira.

With central banks from India to Peru to Egypt cutting rates this year, Erdogan urged Basci last month to follow suit to counter a slowdown in Turkey’s economic growth. When Basci did so, Erdogan said the governor hadn’t gone far enough.

Rate Relief

Should a possible rate cut by Basci silence his political critics, Turkish bonds might get some relief from the market’s slump over the past month, Matys said.

Since Basci’s Jan. 20 rate cut, the yield on Turkey’s two- year lira notes has risen 85 basis points to 8.31 percent on Monday, the worst performance among 21 emerging market securities tracked by Bloomberg. The lira weakened more than 5 percent during the same period, to trade at 2.4817 per dollar at 10:22 a.m. on Tuesday in Istanbul.

Another reason investors dumped Turkish bonds was the volatility in the lira after last month’s rates decision, which ended an earlier rally in Turkish debt, Isik Okte, a strategist at TEB Invest, said by e-mail from Istanbul. Improving inflation expectations and the narrowing of Turkey’s current-account deficit will see foreign inflows resume should the pace of monetary normalization by the Federal Reserve stay linked to economic growth, Okte said.

Tying its Hands

“I am expecting Turkish fixed income inflows to continue with the central bank remaining dovish due to growth concerns, and the timing and severity of the Fed rate hikes remaining data-dependent,” he said.

The upper end of the rates corridor, currently standing at 11.25 percent, serves as a security measure which allows the bank to defend the lira and bonds at times of volatility, said Wolf-Fabian Hungerland, an economist at Berenberg Bank in Hamburg. By cutting that, Basci will be giving up some of the ammunition he might have to use later, he said.

“By cutting the upper end, the central bank will be tying its hands,” Hungerland said by phone. “The implication of this is that bond yields will rise a little bit. There will be a bit of a back-firing moment.”