Supersized Rate Hike Spurs Massive Rally Across Turkish Markets

Turkey’s central bank’s jumbo interest-rate increase triggered a major rally in the country’s assets on hopes that it augurs the unwinding of policies that have sent foreign investors fleeing the $900 billion economy.

(Bloomberg) — Turkey’s central bank’s jumbo interest-rate increase triggered a major rally in the country’s assets on hopes that it augurs the unwinding of policies that have sent foreign investors fleeing the $900 billion economy.

The Turkish lira, long one of the world’s worst-performing currencies, surged the most in almost two years following the announcement on Thursday, to gain nearly 8% against the dollar. Local banking shares jumped, increasing by the maximum regulatory limit of 10%, as dollar bonds advanced. The cost to insure government debt against default plunged.

The Monetary Policy Committee, with newly appointed members led by Governor Hafize Gaye Erkan, surprised markets with a bigger-than-expected hike for the first time since she was appointed in June, raising the benchmark one-week repo rate to 25% from 17.5% in the sharpest increase since 2018. Most economists polled by Bloomberg predicted a hike to 20%.

“Great to see the Turkish central bank wake up the global market from its summer lull, showing it’s in charge,” said Simon Quijano-Evans, chief economist at Gemcorp Capital in London. “Most central banks out there currently have negative real rates. Turkey has more, but it’s getting there, one needs to think positive.”

The move is the strongest indication yet that Turkey’s new administration is prepared to abandon its unorthodox policy set — most notably ultra-low borrowing costs, which even after the increase on Thursday still stand more than 20 percentage points below the latest inflation reading of almost 50%.

JPMorgan revised its estimates for benchmark interest rates and now expects a 250 basis-point hike at each meeting by the end of the year, bringing the year-end policy rate forecast to 35% from 30% previously. Meanwhile, the jump in the currency led Citigroup strategists to close a long dollar-short lira trade recommendation made just a couple of days earlier.

What Bloomberg Economics Says… 

“Turkey’s central bank has stunned by agreeing a supersized rate hike that we see as a front-loaded move aimed at carrying a strong message of a change of policy from the newly installed MPC members. Looking ahead, we expect the central bank’s policy actions to be focused on further revisions and undoing in its complex set of regulations and practices.”

— Selva Bahar Baziki, economist. Click here to read more. 

President Recep Tayyip Erdogan has championed low interest rates, but implementation of his wishes under previous central bank governors caused foreign traders to flee.

Since winning reelection in May to take his rule into a third decade, Erdogan has pledged to support the new economic administration’s shift in course to rein in inflation and get investors back.

The cost to protect against Turkish default using five-year credit default swaps plunged by about 30 basis points, dropping below 400 basis points and trading around 380 as of 6 p.m. in Istanbul. Half of the best-performing dollar bonds in emerging markets were Turkey’s on the day, with its longest-date debt appreciating the most. The notes due in 2047 rose by as much as 2.4 cents on the dollar to around 72 cents.

While Turkey’s overall stock market, the Borsa Istanbul 100 Index, fell by 1.4%, banking shares surged as traders bet they’d benefit from a return to orthodoxy.

Turkey’s one week-repo rate is now at the highest since the nation started to use it as the sole benchmark. Official borrowing costs were last above 25% in 2004, when the central bank used both the overnight borrowing and lending rates to conduct monetary policy.

Thursday’s decision was the MPC’s first since three new deputy governors were appointed late last month. They included a former adviser to the Federal Reserve Bank of New York and the ex-chief economist at one of Turkey’s biggest private lenders.

Piotr Matys, a currency analyst at InTouch Capital Markets in London, said the decision “sends a very strong signal that the central bank is determined to rein in inflation.” The MPC said it “decided to continue the monetary tightening process in order to establish the disinflation course as soon as possible, to anchor inflation expectations, and to control the deterioration in pricing behavior.”

Read more: Ex-NY Fed Economist Among Three Central Bankers Named by Erdogan

Erkan is bringing to an end an era of ultra-loose monetary policy. The governor has said annual price growth won’t peak until the second quarter of next year at about 60%. 

Apart from raising policy rates, the central bank has also taken other measures to increase the cost of money. Its latest regulation took aim at a government-backed savings program that protects account holders from any weakening of the lira. Officials now want them to convert to normal lira deposit accounts.

On Thursday, the MPC said that the recent regulations would “strengthen the monetary-transmission mechanism” and the committee would continue “to make decisions on quantitative tightening and selective credit tightening.”

While Erkan has now brought rates to nearly triple their level when she took over in June, critics continue to question her commitment to tighter policy after two previous decisions underwhelmed traders’ expectations.

“It’s really hard for me to get excited about this hawkish surprise after two straight dovish surprises,” said Win Thin, global head of currency strategy at Brown Brothers Harriman in New York. “Let’s talk after the next decision September 21 and if it delivers another large hike, perhaps things really have changed.”

–With assistance from Joel Rinneby and Tugce Ozsoy.

(Updates with markets in second paragraph.)

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