Hike in Turkey’s interest rates on the cards

In its struggle to defend the ailing lira, Turkey’s Central bank, in a complete turnaround and contrary to the government’s wishes, appears to be about to raise interest rates. Ahead of an extraordinary meeting held at Central bank today, the lira and stock market rallied this morning.

Prime Minister Erdogan meanwhile, insisted that the economy was doing well. Central bank said that it would tighten monetary policy in a “lasting way“ if needed, thereby asserting the bank’s independence.

A decision on what action will be taken is expected around midnight tonight.

“Nobody should have any hesitation that the Central bank will use all available tools,” the bank’s governor, Erdem Basci (pictured above) told a press conference in Ankara.

“The bank will not hesitate to take steps to make lasting tightening in monetary policy if deemed necessary,” he said. “The Central bank is independent and can be held accountable…” he added.

Last July, when the bank began intervening, analysts estimated that it had around US$46 billion to spend but in the last few days alone, it has spent US$4 billion, with little effect

The bank’s governor said that: “A steep decline in forex reserves may cause other concerns, thus the interest rate weapon should be put into use in this environment.”

Basci added: “Our goal during the monetary policy committee meeting will be to undertake steps that will ensure price stability.”

Central bank is expected to raise its overnight lending rate to at least 9%.

The emergency meeting came as Turkey struggles with a political crisis which could threaten PM Erdogan’s premiership and the country’s once buoyant economy.

The government has exerted strong pressure to prevent a rise in base interest rates and on Tuesday, Erdogan played down the tensions, telling parliament that:

“The Turkish economy is quite robust and it is pressing ahead in a resilient way.”

With the elections beginning locally in March, Ankara has pressured the Central bank to not raise interest rates in order to sustain growth.

Up until now, the bank has avoided a steep rise in the base rate, using a big increase in the overnight rate — held at 7.75% last week — and intervening heavily with its reserves on the foreign exchange market.

However, despite massive spending, these measures have done little to protect the lira.

The lira has been breaking record lows almost daily and has lost about 10% since mid-December, when a corruption scandal allegedly involving key government allies became public.

Turkey, one of the main beneficiaries out of a number of emerging markets, has also been hit by the US Federal Reserve’s decision to reduce its stimulus measures.

The main Istanbul stock index, which has lost about 20%of its value over the past year, gained 1.26% to 65,382.07 points.

Analysts say that inflation will remain high as Central bank forecast a sharp increase in inflation this year from 5.3% up to 6.6%. Although the bank assured that inflation would slow from the second half of 2014.

“The higher inflation forecast really just reflects reality – core inflation in Turkey is high and, with tax hikes and the weaker lira, inflation is likely to remain persistently high this year,” economist William Jackson at the London-based Capital Economics said.

Jackson added that: “As for our expectation from the Central bank meeting, it seems that higher interest rates are on the cards.”

However, other analysts have called for more aggressive action. Inan Demir, chief economist at Istanbul-based Finansbank, said: “We think that any rate hike needs to be aggressive enough to push short term rates firmly into double digit territory.”

Adding that it was difficult to predict movements in Turkish monetary policy, he said that: “For now, though, we suspect that a hike in the overnight lending rate (perhaps to 9.0%) is the most likely outcome.”

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