June 7, 2018 / 4:54 PM / a year ago

Markets see Turkey central bank holding steady after hefty rate hikes

LONDON, June 7 (Reuters) - Having jacked up interest rates twice in two weeks to fight a blow-out in the lira, financial markets now see Turkey’s central bank having to hold the line for at least a year.

Turkey ramped up its benchmark rate by 125 basis points to 17.75 percent on Thursday, taking another step to assert its independence, after its emergency 300 basis points increase in borrowing costs late last month.

Signals on what happens now are still a bit fuzzy, but the picture emerging from forward-looking markets is that the bank may have done enough for now, but will need to maintain rates and not ease off.

Three-month ‘forward starting swaps’ for example, which are an indicator of what local banks expect to be charging each other for three month-funding in three months time, are now up at 17.60 percent.

That’s roughly in line with the 17.75 percent rate that the central bank hiked its main ‘one-week repo’ interest rate to on Thursday, and up from 17.15 percent just over a week ago.

“I don’t think the market thinks it (central bank) is going to hike again,” said Kieran Curtis an investment director for emerging markets at Standard Life Investments.

A 1-year FX swap is roughly the same once the effects of compounding are adjusted for and it is only once you look further out that markets see a chance for rates to start coming down again.

In a year’s time the rates for forward starting swaps are back to 16.5 percent, with another 100 basis points coming off a year after that.

“Keeping the policy really tight for a while is definitely what is required,” added Curtis.

FX volatility options also point to slightly less turbulence ahead for the lira which has lost around 16 percent against the dollar this year alone.

The cost of hedging against big lira swings using volatility options was still high historically but had moved down after Thursday’s hike. Spot lira roared up 1.8 percent to back above 4.48 per dollar too.

Traders only make money on volatility options if the actual currency moves more than the priced level, though it can be in either direction.

Reporting by Marc Jones Editing by Hugh Lawson

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