Tightening Cycle Continues: Key Rate Hiked by 500 bps to 30%
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Bottom Line: As predicted, the Central Bank of Republic of Turkiye (CBRT) continued monetary tightening on its fourth monetary policy meeting (MPC) after presidential elections. CBRT hiked the key rate by 500 bps to 30% on September 21, basically to cool off inflation, squeeze demand and cut inflationary expectations. CBRT will likely now pause in Q4, before further tightening in 2024.
Figure 1: Key Rate (%), September 2020 – September 2023
Source: Datastream
After CPI rising to 58.9% y/y in August and the outlook for inflation remaining on the upside and there are strong signs that inflation will continue to rise in the upcoming months mostly due to recent hikes in taxes and salaries, buoyant domestic demand and lending, cost and demand pressures, and weakening Turkish Lira (TRY), CBRT made another rate hike on September 21 MPC and increased the rate by 500 bps, more than expectated.
In its written statement on September 21, CBRT remained concerned about the course of the inflation and stated that “(…) Inflation readings were above expectations in July and August as the strong course of domestic demand and the stickiness of services inflation persist, the increase in oil prices and the ongoing deterioration in inflation expectations pose additional upside risks to inflation while tax regulations and cost pressures stemming from wages and exchange rates continue to push up inflation.”
Despite anti-inflationary actions by CBRT, though, we think impacts of actions remains limited as the deterioration in pricing behaviour dominates and buoyant demand allow companies to pass their cost hikes directly on to consumers while Turkish households struggle with escalating costs. With its recent manoeuvres, CBRT aims to encourage banks to slow loan growth and, in turn, slow private consumption growth, but the transition will take time.
In addition to the tightening process, CBRT continues to simplify and improve the existing micro- and macroprudential framework by taking additional actions to suppress inflationary pressures as well. Following CBRT’s statement on July 25 that the daily limit for rediscount credits for export and foreign exchange earning services was raised to TRY 1.5 billion from TRY 300 million, CBRT announced on September 12 that the daily limit is now raised to TRY 3 billion from TRY 1.5 billion in order to support selective credit utilization and exporters' access to finance. The Bank also implemented recent regulations targeting a rising share of Turkish lira deposits strengthen the monetary transmission mechanism. Despite using a wide variety set of policy tools to stop the accelerating inflation, CBRT still struggles to cool off inflation due to strong inflation expectations and domestic demand, hiking oil prices, and fiscal actions jeopardizing effectiveness of the monetary tightening through igniting the inflation.
We think upside risks emanating from increasing food and energy prices remain high for the country, in addition to the weakening currency, and expected hike in public spending before the 2024 local elections, which could further deteriorate the inflation trajectory. Given forward guidance by the CBRT with disinflation expect to begin in 2024, and macroeconomic stability forecast beginning in 2025, we are of the view that CBRT has showed determination in monetary tightening by hiking the rate from 8.5% to 30% in three months after May elections, and will continue tightening cycle to stop the galloping inflation. USD/Turkish Lira (TRY) weakened by 36.5% in the last three months, clearly showing the loss of value of TRY lately. (Note: We forecast USD/TRY moving to 30 by the end of 2023, and further weakening to 37.5 in 2024 due to elevated inflation, increasing trade and budget deficits and low foreign direct investment (FDI) which continue to dent the currency). Stabilization of TRY is important in cooling down inflation given FX pass-through from a weak TRY, but currency fluctuations continue to prevail causing CBRT to pay close attention to currency developments in addition to inflation when making rate decisions.
CBRT is expected to continue tightening until domestic demand will be suppressed, a weakening pace of TRY is evident, government spending will be controlled, and cost and demand pressures will be alleviated, we foresee inflation will continue to bite, at least until the set of measures would bear fruits. Despite the Central Bank continues to seek to regain credibility and restart foreign inflows through the shift to traditional economic policy moves including increasing the policy rate to 30%, restoring confidence will take time. We foresee that the rate will be kept at 30% until the end of this year before tightening would continue since CBRT would possibly wait to see the impacts of recent rate hikes and additional measures over the economy.