Central bank cuts rates, hints at stronger action

ISTANBUL

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Turkey’s Central Bank trimmed the highest of its main interest rates for a third consecutive month yesterday to prop up a slowing economy, also signaling it would not tolerate more gains for the lira.

With this cut the Central Bank has cut the upper end by 250 bps in the last three months.

The bank cut its overnight lending rate –the upper boundary of the interest rate corridor it uses to control monetary conditions– by 50 basis points to 9 percent but left its other policy rates on hold, in what analysts deemed a cautious move.

The bank kept the policy rate unchanged at 5.75 percent and it did not touch the lower end of the interest rate corridor that stands at 5 percent.

Turkey’s economy expanded 8.5 percent last year, but the government trimmed its forecasts for growth in 2012 to 3.2 percent and forecast only a mild pick-up in 2013. The central bank has been trying to boost growth without allowing the lira to strengthen too sharply.

The prospect of a surge for the currency grew last Monday when agency Fitch gave Turkey its first investment grade credit rating in 18 years, pushing the lira to a three-month high and prompting Central Bank Gov. Erdem Başçı to warn he would act if it appreciated further.

While not taking more dramatic action yesterday, the bank did again tinker with its reserve ratios and said that it could gradually begin to cut its main policy rate, the one-week repo rate, and overnight borrowing rate if needed.

Cautious mode

“This move tells me that the bank is now in a cautious mode, happy to have navigated through the earlier year travails on the exchange rate front, and content to ride through the soft landing phase for a little while yet,” Reuters quoted Timothy Ash, head of emerging markets research at Standard Bank, as saying.

“The message is that it is still a little early to put the foot to the floor on the gas again, when the current account deficit remains large, and financing risks are still considerable,” he said.

“We think that since the Central Bank did not cut its policy rate or lower end today, we expect to see a sell-off in the bond market and stronger Turkish Lira. The Central Bank lowered its effective funding rate just below 5.70 percent, which is even lower than the policy rate of 5.75 percent now. We think that depending on the level of lira the Central Bank might deliver cuts in the lower end of the corridor or policy rate, but we think that we are not there yet,” said Özgür Altuğ, chief economist at BGC Partners, in a research note.

The bank increased the amount of foreign exchange that lenders must provide if they want to hold more than 40 percent of their required lira reserves in forex, in effect raising its reserve option coefficients and tightening the supply of foreign currencies.

“We think the decreasing trend on the upper end of the interest rate corridor has come to an end and the Central Bank will be utilizing liquidity policy to sustain its expansionary stance in the future since the Central Bank refers to policy rate and borrowing rate with regard to its options in the forthcoming period,” said yesterday Odeabank Economic Research and Strategy.