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Categorized | Currencies

Turkey lifts interest rates as pressure builds on emerging markets

Posted on November 24, 2016

Turkey’s central bank raised interest rates for the first time in almost three years, as pressure mounted on emerging markets in the wake of Donald Trump’s election as US president.

The bank’s decision to respond to a weakening lira by increasing the benchmark weekly repo rate 50 basis points to 8 per cent came despite a televised call by President Recep Tayyip Erdogan to cut rates instead.

“Turkey’s real interest rate is among the highest in the world,” Mr Erdogan said on Wednesday. “That makes me very uncomfortable … We need to change that.”

But analysts argued the bank’s move could herald a series of rises in Turkey and elsewhere amid the prospect of an increase in US rates after a decades-long decline — a shift partly due to Mr Trump’s plans to boost US growth by fiscal rather than monetary stimulus.

Such a change in financial conditions — widely anticipated by bond markets — would have profound consequences for emerging markets that have grown used to relatively cheap money.

“Real interest rates have completed their journey south that has taken 30 years,” said Bhanu Baweja, emerging market strategist at UBS. “Emerging market credit conditions are worsening. That’s one tailwind missing and one headwind rising for EMs.”

In what was its first round of monetary tightening since a decision in early 2014, the Turkish central bank also increased the overnight borrowing rate by 0.25 percentage points to 8.5 per cent.

The lira briefly strengthened from a record low of TL3.42 to the dollar before weakening again on news the European Parliament cast a non-binding vote to suspend membership talks with Turkey. By mid-afternoon it had fallen to almost TL3.43. The currency has plunged as much as 18 per cent against the dollar this year alone, as investors around the world prepare for the US Federal Reserve to raise rates and seek safer assets such as the Japanese yen and gold after Mr Trump’s election victory.

Currencies such as the Mexican peso have also charted new depths since the election, while a broad index of EM currencies has neared a record low of its own.

South Africa, another country whose currency has been under pressure from the markets, kept its benchmark repo rate on hold at 7 per cent on Wednesday. But analysts said Turkey’s central bank would be forced to raise rates again, noting $210bn of foreign currency debt owed by the country’s non-financial corporate sector, which arguably puts it among the emerging economies most at risk from any rise in US interest rates.

“The country’s large external vulnerabilities mean we think significant further tightening lies in store,” said William Jackson, senior emerging markets economist at Capital Economics.

Turkey’s political turbulence has also chipped away at growth, consumer spending and the lira, as Mr Erdogan has threatened a referendum to call off the accession talks with the EU and purged political opponents.

JPMorgan Chase predicts the lira will end the year at 3.50 to the dollar, and 3.65 in 2017.

At an economic co-ordination meeting chaired by Mr Erdogan on Wednesday the Turkish president focused on the lira’s drop, after claiming interest rates and bankers had toppled the Ottoman Empire and threatening an intervention to stop high interest rates from choking growth.

“I am calling on lenders: please reduce interest rates to reasonable levels,” he said at a separate event on Islamic lending. “If we want growth, we need employment, investment and competition. Unemployment is above 11 per cent; is this what this country deserves?

Mr Erdogan lambasted the central bank’s previous governor as a traitor for keeping rates high. The new governor, Murat Cetinkaya, who took office this year, initially followed Mr Erdogan’s lead, dropping rates for the first few months and subsequently holding them steady as he simplified monetary policy.