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Turkish Central Bank Paves Way for Rate Hike After Lira Slide

FIILE - A woman walks past a currency exchange office in downtown Istanbul, June 21, 2013.
Turkey's central bank signaled on Monday that it is set to raise interest rates to stabilize a plunging lira, after intervening heavily last week to shore up the currency as it sank to record lows.

In a rare written statement ahead of a monetary policy committee meeting, Governor Erdem Basci said global policy uncertainty and volatility would not be allowed to damage financial and price stability in Turkey.

“A measured step to widen the interest rate corridor will be on the agenda of the next monetary policy committee meeting,” Basci said in the statement ahead of the bank's July 23 meeting.

That suggests the bank is ready to try to stabilize the market by raising its overnight lending rate, the upper end of the 'corridor' or gap between the rates at which it lends and borrows money to keep markets and the currency steady.

Emerging markets like Turkey have been hit hard since early May, when the U.S. Federal Reserve signaled it may begin withdrawing its stimulus, the first hint of a U-turn in the easy policy the world's major central bank have implemented since the financial crisis.

Last month's anti-government protests across Turkey added to pressure on the lira.

The central bank appears to be ready to take action to support the currency, even though Prime Minister Tayyip Erdogan will be reluctant to see a rate hike that slows economic growth.

In a presentation to parliament published later on Monday on the central bank website, Basci said the bank would continue to take the necessary measures to maintain market stability and said capital inflows had weakened recently.

The currency firmed to 1.9380 to the dollar by 1533 GMT from 1.9450 before the bank's statement. The yield on 10-year government bonds fell, as did the cost of insuring Turkish debt, with five-year credit default swaps down 11 basis points from Friday to 208 bps, according to Markit.

“The CBRT [central bank] bows to the inevitable ... clearly indicating that it will hike the top end of the rates corridor,” said Timothy Ash, head of emerging markets research at Standard Bank.

Raising the lending rate would effectively increase the real interest rate on lira assets, making them more attractive to foreign investors.

In a presentation to parliament published later on Monday on the central bank website, Basci said the bank would continue to take necessary measures to maintain market stability and said capital inflows had weakened recently.

Burning Up Reserves

The central bank had stepped up its foreign currency auction sales since June 11 in a bid to underpin the currency, and has now sold $6.3 billion this year. But analysts have pointed out that this only runs down the country's net reserves, which bankers calculate have fallen below $40 billion.

“The CBRT is acknowledging by these actions that its prior strategy of using FX reserves to defend the lira simply was not working, and risked just blowing scarce reserves away,” said Ash.

Bankers say the central bank may have to raise the upper end of the rate corridor by at least 100 basis points to stop the currency slide.

“The announcement shows that the CBRT is ready to take action to calm the markets. This announcement is likely to stop the speculation that the CBRT is against any kind of rate hikes,” JP Morgan analyst Yarkin Cebeci said in a note.

The central bank's overnight lending rate is currently at 6.5 percent, its one-week repo policy rate at 4.5 percent and its overnight borrowing rate, the lower end of the corridor, at 3.5 percent.

Erdogan's AK Party has taken Turkey from a crisis-prone economy to Europe's fastest-growing over the past decade, helping it to win three successive elections. It is a record Erdogan is keen to maintain as elections approach next year.

Erdogan said on Monday the central bank and other institutions were acting “with determination” in response to market volatility and the hints of a tighter Fed policy.

“Our central bank and other relevant institutions are taking the necessary steps in a timely fashion in coordination and with determination to minimize the negative impact of these developments which are affecting all emerging markets,” it said.

The central bank has been reluctant to hike rates following a credit-fuelled boom, while Erdogan, aware of the negative impact on Turks of higher borrowing costs, has blamed a “high interest rate lobby” for instigating anti-government protests.

“Higher policy rates will inevitably mean lower growth, and it will be interesting to hear the reaction from policy hawks in the government,” Ash said of the central bank statement.

“It is interesting how the CBRT has announced this move pre the July 23 MPC meeting - clearly they hope that this 'verbal intervention' will limit the extent they will have to hike the lending rate come that day.”