November MPC: Waiting For Further Hikes

The monetary policy committee raised 1-week rate by 50 bps to 8% and the upper band by 25 bps to 8.50% vs a consensus expectations split between a 25 bps hike in the 1-week repo change and no change. As a separate decision, the central bank has decreased FX reserve requirements by 50 bps for all maturity brackets, providing $1.5 billion of liquidity to the financial system.

The move came despite the politicians’ strong remarks against high real interest rates, but after Turkish lira has weakened almost 9% against the US dollar (even underperforming the Mexican Peso). To our thinking, this was a rational move but not enough to reduce near term risks. The rate statement noted that despite the disinflationary slowdown in aggregate demand, recent exchange rate movements ─owing to heightened global uncertainty─ posed upside risks to the inflation outlook while it did not provide much forward guidance.

The average cost of funding rate was standing at 7.9% just before the decision, and according to our estimates the rate hike could add another 35 bps, taking it to 8.25% in days to come. That said, we have already seen it rising to 9.05% in two days following the rate decision. We believe much of the devaluation in the local currency has been driven by global market conditions, and Trumpflation trade is likely to lead further downside. While our 2016E USD/TRY target of 3.2 is overshot by a wide margin, we renew our 12-month horizon target at 3.65 for the currency. We also believe that 25 bps hike in the ceiling of the rate corridor may not provide sufficient incentive for deposit holders to stay in TRY.

turkey-real-interest-rate-and-core-inflationPreviously, we draw a pessimistic future for the inflation outlook in 1H17. Correspondingly, we see further rate hikes by the central bank going forward, and expect the average cost of funding to hit 10% next year, in an effort to provide a compelling real interest rate for TRY holder. In our view, the recovery signals in Q4 ─after a dismal Q3─ on the lending growth front, would provide some comfort for the central bank for tightening. That said, we earlier stated that it was more likely to see fiscal stimulus to support the economic activity in the future (we expect Turkish government to post a budget deficit of 2% as of GDP in 2017).