EMRE DELİVELİ >Markets getting ahead of the Central Bank

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One of the leading Turkish economy themes of thispast week was the large decline in government bond yields. 

After falling from 9.45 to 8.85 percent in June,the benchmark government bond finished the week at just above 8 percent onFriday. Accordingto Bloomberg, remarks from Central Bank Governor Erdem Başçı that the Bankmight revise down its inflation forecast had already triggered speculation thatthe policy rate might be cut. 

Markets got what they wanted last week, as theCentral Bank lowered the averagefunding rate of banks, which is the effective policy rate, to 8.20 percenton Friday from 9.02 percent the week before by lending to banks at the one-weekrepo rate of 5.75 percent throughout the week. Markets were also responding to June inflation. At 8.9 percent, yearly inflation turned out to be much lowerthan expectations of 9.5 percent. 

The key question is whether this easing willcontinue. The answer is important not only for
Mrs.Watanabe the Japanese housewife and the Mayfair hedge fund manager, savingfor retirement and an Aston Martin respectively, but also for most of myreaders, as lower rates will weaken the lira, which so far has held up well. 

Markets seem to be expecting more of the same. Notonly did their year-end inflation expectations fall sharply, growth dynamicsseem to support lower rates. While first quarter growth,
at3.2 percent yearly, came in better than expected, domestic demand was veryweak, and the most recent leading indicators are hinting that economic activitymay not pick up during the second half of the year, as widely expected. 

There is also the expectation that
Thursday’s actions by the European CentralBank, the People’s Bank of China and the Bank of England may tempt the CentralBank of Turkey to go ahead with its own easing as well. I beg to disagree. Afterfalling behind for a long time, markets may now be getting ahead of the CentralBank. 

For one thing, the mild inflation turnout wasmainly due to the recent fall in oil prices and favorable food inflation. Oilprices are creeping up again because of
Iran-relatedpolitical worries. Turkish food prices are notoriously volatile and subjectto sharp reversals, as arecent Citi research note underlines. Actually, the Bank made these pointsat their most recent meetings with economists.

Başçı is probably not too happy with the market'sexpectation that interest rates will be lowered further, as it may weaken thelira.  
Duringa speech on Friday, he emphasized that a downward revision of the Bank’s end-yearinflation forecast of 6.5 percent would not lead to easing. The Bank seems toprefer bringing inflation as close as possible to the 5 percent inflationtarget instead.

Finally, despite the recent improvements in thecurrent account, the balance of payments picture remains challenging. Unlesscapital inflows, which have so far remained low relative to the current accountdeficit, pick up in the second half of the year, the Bank will not have muchroom to ease without hurting market sentiment and putting pressure on the lira.

To sum up, the hedge fund manager’s Aston Martin,as well as your and Mrs. Watanabe’s lira savings, seem to be safe for now.


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