Bad timing by the Turkish central bank

The Turkish central bank decided at its latest meeting to leave key interest rates on hold at 24.00% – so far, so good. Less good is that the accompanying statement now fails to contain the reference to the possibility of adopting further tightening measures as required. Monetary policy is now said to be aligned in such a way as to keep the inflation rate within the target range. Markets interpreted this as a signal that the tight monetary positioning was to be softened. This had the effect of unsettling the lira which at times fell against the euro and the US dollar to its lowest level since October last year.

A closer examination shows the altered positioning of the central bank to be quite comprehensible when viewed against the fundamental backdrop. Price pressure has eased up noticeably in recent months and can be expected to ease further looking ahead. With the economy having slipped into a deep recession in the second half of 2018, the development of gross domestic product also offers little reason for an excessively tight monetary policy. And little more than frail signs of stabilization could be noted in the first quarter of 2019.

But from the lira’s perspective, the timing of the latest shift in monetary policy could not have been worse. A number of factors have recently weighed on sentiment against the national currency: the tense domestic political situation since the local elections at the end of March, the ongoing conflict with the USA over the purchase of a Russian air defense system for the Turkish army, and the US dollar’s current show of strength. Compounding this is the fact that investors have become wary of placing too much trust in the central bank in Ankara in response to the experiences of last summer. If the central bank’s measures prove ineffective and price pressure fails to ease up further, the lira can expect to depreciate even more. Otherwise today’s statement can be viewed as an appropriate step towards a normalisation of monetary policy in Turkey. We essentially concur with the latter interpretation – at the moment.

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