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Turkey Central Bank Starts ‘Strong’ Tightening to Bolster Lira

People line in front of automated teller machines in Hatay, Turkey, May 17, 2013.
People line in front of automated teller machines in Hatay, Turkey, May 17, 2013.
Reuters
 Turkey's central bank auctioned a record $1.5 billion in foreign exchange on Monday, tightening policy to defend a lira that had hit all-time lows against the dollar.

The lira has lost as much as 6 percent of its value against the dollar since late May, when unprecedented protests broke out against Prime Minister Tayyip Erdogan. Demonstrations centered on the commercial capital Istanbul compounded investor concerns about the U.S. Federal Reserve scaling back stimulus measures.

On Monday, the lira touched a new all-time low of 1.9737 against the U.S. currency. It rebounded to 1.9480 by 1151 GMT after the bank held five forex-selling auctions.

The total volume of $1.5 billion was the highest amount the bank has ever sold via forex auctions in a day, sending a strong signal to the market. The previous high was $750 million in 2011. The bank sold $350 million in six auctions on June 20.

Emerging currencies have plunged to multi-year or even record lows against the resurgent dollar. That is forcing many central banks to rally to their defense on fears currency weakness will lead to a wholesale exodus of foreign capital from domestic capital markets.

“From today a strong additional monetary tightening practice will be started,” the Turkish central bank statement said, delivering what it described as a message from Governor Erdem Basci. Tightening would be “strong, effective, temporary.”

“The central bank thinks as loan growth remains strong, there is no need to change the interest rate band yet, while additional tightening as implemented occasionally since 11 June and forex sales will be adequate to fight against volatility,” said Sengul Dagdeviren, senior vice president at ING Bank.

“Until [the] ... 23 July policy meeting, the central bank is most likely to continue aggressive forex sales to the extent lira's relative volatility against peers remains high while keeping cost of average open market operation funding in the range of 5 percent-6 percent.”

Protests against Erdogan, seen by critics as increasingly authoritarian, spread across Turkey last month after police cracked down on a small demonstration against an Istanbul building project.

Erdogan has used a huge parliamentary majority and strong popular support in the last 10 years to introduce social reforms, including the curbing of an army that had topped four governments in 40 years, and stimulate the economy with market-  and business-friendly policies.

But for the first time, during last month's turmoil, frictions arose publicly with parts of the business community. Erdogan  unsettled markets further by accusing an “interest rate lobby” of conspiring with foreign forces to undermine Turkey.

The protests eased in the middle of the month, but police used water cannon and tear gas again at the weekend to disperse a protest in central Istanbul.

The central bank has been holding forex auctions since June 11 to support the weakening lira. It has sold a total $4.15 billion.

“I guess the central bank had to respond, eventually, to record lows for the lira against the dollar and signs that more was to come,” said Standard Bank emerging market research head Timothy Ash.

“So by indicating further tightening ahead the central bank is in effect going to try and slow domestic demand to narrow the current account deficit - as it did in early 2012.”

Faster output

At a meeting with economists on Monday, Basci gave the message that its additional tightening steps were aimed more at limiting loan growth than supporting the lira, bankers at the meeting told Reuters.

The governor also said that a change in the bank's interest rate corridor would only be implemented if the liquidity tightening fails to prevent excessive loan growth, bankers said.

In a written overview of its presentation to economists, the bank said this will not only contain rapid credit growth through the liquidity channel but also will support the value of the lira.

Growth slowed sharply to 2.2 percent last year and the central bank has been trying to spur the economy since mid-2012 with a series of rate cuts.

Data on Monday showed the economy remained sluggish, with industrial production up just 1 percent year-on-year in May.

Economy Minister Zafer Caglayan responded by saying Turkey needed faster output growth to meet its 4 percent economic growth target in its medium term economic program, given uncertainties in the global outlook.

Analysts said the pressure on the central bank to hike rates at its next policy meeting on July 23 was increasing.

“The central bank will pause weekly repo auctions and start aggressive forex selling auctions from today,” said Ali Cakiroglu, a strategist at HSBC Asset Management.

“The bank will have to raise the upper band of its interest rate corridor in its next meeting considering the pressure on the currency.”

In its last policy meeting the bank kept its main one-week repo rate at 4.50 percent, its borrowing rate at 3.5 percent and its overnight lending rate at 6.5 percent.

The bank said the composition of the liquidity it provides will continue to be gradually shifted from net foreign assets to net domestic assets until its next monetary policy committee meeting.

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