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CBRT: The rate cut cycle stops, with the increase in inflation

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The Central Bank of the Republic of Turkey did not change the interest rates at its January meeting by pausing the easing, which it has continued in series since the previous months and reached 500 basis points in total. In this context, the 1-week repo rate remained at 14%, in line with the consensus estimate of the market and our expectation. In the ongoing policy easing, especially a perspective regarding the target of low borrowing costs, which was also put forward by President Mr. Recep Tayyip Erdoğan, was adopted. In this process, in addition to the uncontrollable factors in inflation, the volatility of the lira had risen to very high levels, and the tightening trend in global financial conditions also contributed to price fragility and deterioration, heating additional risks on inflation. We think that the Board’s decision to keep the interest rates constant was due to the fact that the easing was mostly front-loaded in the previous months and that the decisions taken might have wanted to see the effect of the high readings in inflation. As it will be remembered; In the MPC statement in December, it was stated that the developments in the 1Q22 period would be followed and monetary policy would be evaluated.

 

There are high growth rates in line with the demands and targets of the political power and economy management. In this economic perspective, which is the mainstay of the easing cycle, inflation accelerated with the deteriorating lira stability in the last months of 2021, rising to 36.1% in December, the highest reading since 2002. Therefore; Real interest rates – policy rate minus current inflation – fell to minus 22.1%, by far the lowest rate among major emerging markets. With the acceleration to be seen in inflation in the coming months, negative real interest rates will deepen and remain well below the standards of developing countries.

 

Highlights from the Central Bank’s decision and policy text;

 

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·        The one-week repo rate remained unchanged at 14% (median market estimate 14%). All 20 economists in the Bloomberg poll were expecting 14%.

·        The latest increase in inflation is due to “distorted pricing behavior due to unhealthy price formations in the foreign exchange market” and supply-side factors.

·        The Bank is reviewing the policy framework to prioritize the lira in all central bank policy instruments.

·        The Bank expects the disinflation process to begin with the effect of the measures taken for sustainable prices and financial stability, as well as the decline in inflation due to the base effect.

 

At this stage; We can see the rising price pressure and its destabilizing effect as factors that caused the Central Bank to stay on hold. Here, if we look at the inflation guidance in the MPC text; Along with the evaluation of “distorted price behavior arising from unhealthy price formations in the foreign exchange market, supply-side factors such as the increase in global food and agricultural commodity prices, supply constraints and demand developments”, “the expectation that a decrease in inflation will begin soon” is put forward. In this context, the Central Bank may also consider the base effect, which will begin after a certain part of the year, at a point of disinflation, because the extremely high periodic price increases towards the end of 2021 may help reduce annual inflation in case of near-normal inflation rates in the 2022 conjugate period. We are on this subject; We think that there may be an inflation decrease that can be seen in the last quarter of the year, but an inflation balance may occur somewhere on the Central Bank’s possible forecast path. Although seeing the May period as a possible peak in CPI inflation, there may be a decline towards the 30% path due to the heavy base effect of November and December. January, February and March will be the months when we will experience the fastest rise in inflation.

 

On the other hand, we cannot be very optimistic about the near-term inflation expectations. The sharp lira depreciation in the last few months continues to be fed into consumer prices. In addition, we evaluate the impact of the high 50% increase in the minimum wage on product prices due to the short-term demand and operating costs impact. With the new year, the sharp increase in service prices (natural gas, electricity) will also cause an upward price pressure both on the end consumer and on the axis of increasing industrial costs. In the short-term inflation outlook, we will continue to observe the impact of cost increases in line with the local pricing behavior and exchange rate. Global conditions are still challenging and rising US interest rates may renew the pressure on the lira. The recent increase in oil prices and the price hikes to be applied in the axis of exchange rate + global prices and the cost increases that will occur in this way may trigger the increase pressure on both producer and consumer prices.

 

The range of expectations for the Central Bank to raise interest rates by the end of this year is very wide. At this point, when we make an overview of economist views; There are diversified expectations that the policy rate may be within a wide range of 9% to 20% by the end of the year. Those who think that the interest rate will be higher than it is now, take it as a basis that market conditions and price developments in the economy will force the Central Bank to tighten again. Expectations that interest rates may decrease are related to the demands and targets to provide low borrowing costs despite rising inflation and global tighter monetary policies.

 

If we look at the views of the economy management and the government; In his most recent statement, Mr. Erdogan evaluated that a gradual path would be followed to reduce interest rates. In the general policy motto, the government and the economy management want the borrowing costs to be lower. Therefore, we think that current conditions still do not include a policy tightening, but may bring about a pause in monetary policy for a certain period of time. Against this; When we compare the central bank guidance and the aforementioned statements, we can see that one end is open. Namely; In the January meeting of the CBRT, the sentence “The cumulative effects of the decisions taken in the 1Q22 period will be closely monitored” included in the previous MPC text, replaced by “The cumulative effects of the decisions taken in the 1Q22 period are closely monitored and the CBRT has to reshape price stability on a sustainable basis in this period. A comprehensive policy framework review process is underway, giving priority to the Turkish lira in all policy instruments”. The time frame for keeping the policy rate unchanged, or rather not lowering it for a while, may exceed the 1Q22 period, especially due to inflation and lira developments.

 

However, we are still at an early stage to include the possibility of rate hikes in the discourse of “policies that give priority to TRY”. The new currency protected TRY deposit product, which was launched on 20 December, was an indicator of the current economy management’s desire to eliminate the risks regarding the lira and to prevent the escape from the lira. We still think that TRY investment incentives similar to side policy instruments and currency protected deposit product can be brought to the fore. In addition to financial products, the central bank may also make some side policy adjustments (such as reserve requirements, swap facilities) that will affect foreign currency and lira liquidity. We are at a moderate point in terms of the stability of the lira and, naturally, the effects of such products and steps on inflation, and we think that they do not eliminate the main risk factors. The level and direction where inflation will remain will continue to keep the real interest rates of the lira in the deep negative zone. Of course, we make this prediction with the assumption that the policy rate will not be increased rapidly. We think that the volatility in TRY will continue as long as a return to generally accepted economic policies and a reaction mechanism are not established around the main policy.

 

The January 27 Inflation Report, which will show the central bank’s price increase and output gap forecasts for this year, and the January consumer price index data, which will be announced on 3 February, will be the next topics to be followed. We will also have the opportunity to see the convergence of the central bank’s forecasting path with the market consensus in this direction. Of course; We will also make inferences about Mr. Kavcıoğlu’s answers to economist questions within the scope of basic policy. For the MPC on February 17, we assume that conditions similar to today are valid and that there will probably be no interest rate changes. We consider that the main determinant and purpose of policies is related to the new economy perspective, but the short-term periodic outlook is related to exchange rates, market conditions and inflation.

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