ZERO HEDGE - TURKISH LIRA CRASHES AFTER CENTRAL BANK UNEXPECTEDLY KEEPS BENCHMARK REPO RATE UNCHANGED

Turkish Lira Crashes After Central Bank Unexpectedly Keeps Benchmark Repo Rate Unchanged

by Tyler Durden

Jan 24, 2017 6:19 AM

With Wall Street consensus expecting the Turkish central bank to hike its benchmark repo rate by 50bps (in two cases by as much as 75 bps and five analysts were expecting as much as a 100 bps increase) in hopes of arresting the recent record collapse in the Turkish Lira, this morning the central bank again proved it has become a political appendage of Erdogan, who has repeatedly stated he is against any rate hikes, when the central bank kept its overnight benchmark repo rate unchanged at 8%, even as it raised its less relevant overnight lending rate by the expected 75 basis points.

The latest breakdown of Turkey's rates:

Benchmark repo rate: 8%
Overnight lending rate: 9.2%
Overnight borrowing rate: 7.25%
The disappointment was particularly acute following a November decision to hike rates by 50 bps, the first such increase in more than two years.

As a result, the lira plunged nearly 2% with USD/TRY surging as much as 1.9% to session high of 3.8284.

In its justification, the central bank said that it can deliver further tightening if needed, noting "inflation expectations, pricing behavior and other factors affecting inflation will be closely monitored and, if needed, further monetary tightening will be delivered."

“Moreover, necessary liquidity measures will be taken in case of unhealthy pricing behavior in the foreign exchange market that cannot be justified by economic fundamentals.”

"Recent data indicate partial recovery in economic activity, which is “expected to continue at a moderate pace. Yet, excessive fluctuations in exchange rates since the previous meeting have increased the upside risks regarding the inflation outlook"

It concluded that “significant rise in inflation is expected to continue in the short term due to lagged pass-through effects and the volatility in food prices.”

In other words, expect Turkish inflation to soar in the near future as the currency crash accelerates, all the while Erdogan blames some vast foreign conspiracy to overthrow him.

Some more thoughts from Goldman, which writes after the announcement that the "TCMB raised the overnight lending rate and the late liquidity rate in line with consensus expectations and more than we had expected but kept its repo rate unchanged vs consensus expectations of a 50bp hike."

The corridor between the lowest and highest lending rates has hence been widened significantly, implying that the Bank prefers to use liquidity management rather than straight rate hikes to fend off pressure on the currency. Arithmetically, the interest rate adjustments translate into an 80bp hike at the current funding mix, raising the average cost of funding to 9.8%; the upper end of the corridor, at 11%, is now close to the level we think rates would need to rise to for the TRY to be stabilised. In our view, the market was hoping instead for a clear upward shift in the interest rate corridor, suggesting that exchange rate volatility is likely to remain high.
Details:

The TCMB raised the upper end of its interest rate corridor in line with consensus expectations and by more than we had forecast. But it left the repo rate (the lowest lending rate) unchanged, compared with consensus expectations of a 50bp hike.
At the current funding mix, the decisions would raise the average cost of funding by roughly 80bp to 9.8%, with the upper end of the interest rate corridor, at 11%, now close to the level that we think is necessary to stabilise the TRY.

This leaves the policy corridor even wider than it was previously, indicating that the TCMB intends to use liquidity management rather than straight rate hikes to fend off pressure on the currency. This is more or less in line with our thinking on the reaction function of the TCMB. Instead, the market was looking for a more meaningful hike in the entire interest rate corridor and hence the TRY sold off on the decision.

In the accompanying statement, the TCMB said that, although demand conditions are supporting disinflation, in the short run the exchange rate pass-through will put upside pressure on inflation. Arguably, the TCMB is saying that the tension between the short- and long-term drivers of inflation is motivating it to use tighter liquidity measures rather than the less easy to reverse rate hikes to stabilise the TRY. However, liquidity management rather than rate hikes is, in our view, less well suited to stabilise expectations.

The statement also makes clear that the TCMB will continue to use all options available to pursue price stability. It now explicitly says that it will use liquidity measures in the event of unhealthy pricing behaviour in the foreign exchange market. Instead, it says it will use monetary tightening to fend off inflation pressure. However, given that the Bank widened the interest rate corridor without lifting the bottom of the corridor, it is hard to see the difference between monetary tightening and liquidity management.
Given the strategy of the TCMB to keep a high degree of interest rate flexibility, we suspect that exchange rate volatility will remain elevated.

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