Are Rates Still Low Despite The Massive Hike?

The whole world was shocked when Turkish Central Bank raised its policy rate to 10% from a lending rate of 7.75%. Market reacted quickly to this massive hike. We saw lira abruptly gaining value and flirting with 2.17 against dollar, EEM (iShares MSCI Emerging Markets ETF) rallied an so on. But the question still remains. Are rates high enough to attract foreign investors in order to provide the capital inflows towards the country which has the highest foreign debt as of its GDP among major emerging economies.

Here is the most shared chart on Twitter last week:

Taylor-rule-and-EM

This chart is also explaining what may happen when policy makers in emerging economies go against the principles of macroeconomics. The negative reel rates era in developed world let the emerging one build welfare economies but not in a sustainable way. The time for repayment is likely closing in. What meant $20 billion Fed tapering to Brazil and Turkey was raising rates.

Should we expect Turkish Central Bank to continue to tightening its policy further? We have some reasons to think so. There are the most important lines from release by the central bank.

Tight monetary policy stance will be sustained until there is a significant improvement in the inflation outlook. Under this policy stance, inflation is expected to reach the 5 percent target by mid-2015

This morning we had the inflation numbers for January that came out higher than market expectations with a 1.72% rise month over month, meanwhile annual inflation rose to 7.48% that is followed by increases in year-end inflation forecasts by global investment banks. Additionally, the survey of expectations made by Turkish Central Bank tells us the similar story.

Turkey - Inflation Expectations

Respondents indicated that, on average, they expect unit costs to rise 7.1% over the next 12 months with a sharp increase from the expectations of 6.7% one month earlier.  2 years-ahead inflation expectations also rose at the end of January. If the trend remains up in next surveys, this will prove that market’s belief that rates are set lower that they should be.

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