May 9, 2019 / 5:46 PM / 2 months ago

Skidding Turkish lira tests central bank's desire for rate cuts

ISTANBUL, May 9 (Reuters) - The Turkish central bank’s stopgap moves on Thursday to support the lira could prompt it to reverse course and raise interest rates this year in the face of a months-long currency selloff and uncertainty over a re-run of Istanbul elections.

Yet with President Tayyip Erdogan’s dim view of rate hikes in the midst of a recession, analysts say the bank would likely only tighten policy if a sharp correction were to hit the Turkish currency as it did in August last year, when the lira lost some 30 percent.

After the central bank suspended repo auctions and tweaked reserve requirements on Thursday, money markets were pricing in steady rate hikes.

The 1- and 3-month LIBOR rates show that the policy rate, now at 24 percent, could rise to as high as 33.5 percent in a year. The market may not properly reflect pricing, some traders say.

“The measures today provide short-term relief but are not enough to restore confidence in the lira and contain lira depreciation in the longer-term,” said Nikolay Markov, a senior economist at Pictet Asset Management.

“For that to happen, there needs to be a hike in interest rates,” he said.

The central bank last raised its policy rate in September to counter inflation and last year’s full blown currency crisis. It has not moved since, and in a policy statement last month it dropped a previous reference to possible further tightening.

The bank’s moves on Thursday had little impact on the lira, which hit its weakest level in eight months.

The latest slide in the lira came after Turkey’s election authority annulled March Istanbul election results and set a re-run on June 23. That sparked concerns that the government would resort to short-term stimulus and divert attention from much-needed structural reforms to lift the economy from recession.

Economists say the central bank resorts to such “back-door” moves in order to tighten policy to avoid being reprimanded by Erdogan, a self-described enemy of interest rates.

The central bank’s suspension of one-week repo auctions will cause the average cost of average funding to increase gradually to 25.5 percent, the bank’s overnight lending rate.

The next step by the central bank might be to fund through its late liquidity window rate, which now stands at 27 percent, said Inan Demir, senior emerging markets economist at Nomura. (Additional reporting by Tom Arnold and Marc Jones in London; Writing by Ali Kucukgocmen; Editing by Jonathan Spicer/Mark Heinrich)

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