CBRT Continued Strong Monetary Tightening on October 26 MPC
Bottom Line: Unlike our expectations, Central Bank of Turkiye (CBRT) continued its monetary tightening cycle by hiking the key rate by 500 bps to 35% at the October 26 MPC, despite predictions that the Bank would likely wait and see the lagged impacts of the strong tightening process this time. According to the written statement published, CBRT remained concerned about inflation readings staying above expectations in the third quarter, the strong course of domestic demand, the stickiness of services inflation, and the deterioration in inflation expectations. We now expect CBRT to hike the rate to 40% at the end of 2023, by raising the rate by 250 bps in the last two MPC of the year which are scheduled for November 23 and December21.
Figure 1: Key Rate (%), September 2020 – October 2023
Source: Datastream
The CBRT raised the policy rate from 30% to 35% on October 26 MPC meeting to establish the disinflation course as soon as possible, to anchor inflation expectations, to control the deterioration in pricing behaviour and to squeeze demand, as inflation continues to bite.
Despite predictions on CBRT likely temporarily pausing hikes this time as the accelerating pace of inflation slowed down and the weakening pace of TRY decelerated in September, it appears the Bank decided to further tighten the policy to establish the disinflation course as soon as possible. It is also seemed concerned with recent geopolitical developments posing risks to the inflation outlook due to higher oil prices.
According to the statement by the CBRT, while the year-end inflation is projected to be close to the upper bound of the forecast range provided in the Inflation Report, the Bank evaluated that the underlying trend in monthly inflation is on course to decline, signalling the tightening cycle is effective so far.
The Central Bank also noted that the monetary transmission mechanism will remain strengthened by taking additional steps. Taking into account that the CBRT continues to encourage increasing the share of Turkish lira deposits through gradually decreasing the KKM (exchange rate protected deposits), which can be considered as a major policy change when compared to policies implemented before the pre-presidential election in May, the Bank consolidates its position via making decisions on quantitative tightening and selective credit tightening to support the monetary policy stance.
Taking into account that CBRT vigorously increased the key rate by 2650 bps to 35% after June, coupled with measures aiming to simplify and improve the existing micro- and macroprudential framework to suppress inflationary pressures, the course of the transition process remains very fast as the lagged impact of the tightening cycle is still feeding through, and we still think the economic actors may still need some room to digest the impacts of the tightening process.
CBRT also said it would strengthen monetary tightening in a “timely and gradual manner” until the inflation outlook improves. Since Inflation is forecast by the central bank to reach 60% by the end of 2023 and TRY continues to plummet, and CBRT remains dedicated to start the disinflationary process as soon as possible, we expect CBRT to raise the rate to 40% at the end of 2023, by lifting the rate by 250 bps in the last two MPC of the year scheduled on November 23 and December21.
Of course, no hikes in the last two meetings is also possible, particularly if the decline in the course of inflation will be apparent, and weakening pace of TRY decelerates. Despite this, we continue to foresee upside risks emanating from increasing food and energy prices are high for the country, in addition to the weakening currency, and the expected hike in public spending before the 2024 local elections would likely lead to Q4 2023 inflation to soar to 69%.
CBRT continues to gain investor credibility thanks to recent hikes and decent communications, there is still a need for positive real interest rates to keep investor confidence stable in the midterm.