Investors brace for possible rate cut amid Turkey’s 80% inflation

An electronic board displays exchange rate information at a currency exchange office in Istanbul, Turkey, Monday, August 29, 2022.

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Investors are bracing for another potential rate cut – or simply staying at the current rate – as Turkey refuses to follow economic orthodoxy in battling its soaring inflation, which now tops 80%.

Or indeed the investors who can still endure the volatility of the Turkish market.

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The Eurasian hub of 84 million – which still has significant exposure from many major banks in Europe and the Middle East and is highly exposed to geopolitical tensions – has seen major market turmoil in recent days, on top of dramatic currency losses in the last few years.

This week, Turkey’s stock market, the Borsa Istanbul, took a major hit, with Turkish bank shares down 35% in the week ended last Monday after staging a 150% stratospheric rally between mid-July and mid-September. It prompted regulators and brokers to hold an emergency meeting, although they ultimately chose not to intervene in the market.

The cause of the volatility? First, high inflation in Turkey had prompted investors to put their money into stocks to protect the value of their assets. However, analysts believe fears of higher US inflation and consequent rate hikes by the Federal Reserve likely triggered the sudden downturn.

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The decline wiped out more than $12.1 billion in market value at the country’s publicly traded banks.

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This is because higher US interest rates and a resulting stronger dollar mean trouble for emerging economies like Turkey, which import their energy supplies in dollars and have large dollar debts, and therefore have to pay more for them.

The market crisis led to margin calls, when brokers require investors to put money into their positions to cushion losses in stocks they bought with “margin” or borrowed money. That led to sales surging until Turkey’s main clearing house, Takasbank, announced on Tuesday an easing of collateral payment requirements for margin trading.

Bank stocks and the Borsa as a whole rebounded slightly on the news, with the stock market up 2.43% since 2pm Monday in Istanbul. Borsa Istanbul is still up 73.86% year-to-date.

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Rising inflation: what’s next from the central bank?

However, analysts say the stock market’s upbeat move is at odds with Turkey’s economic reality as they look ahead to Turkey’s central bank’s interest rate decision on Thursday.

With inflation hovering just over 80%, Turkey shocked markets in August by cutting interest rates by 100 basis points to 13% – sticking to President Recep Tayyip Erdogan’s firm belief that interest rates will only increase inflation, which is far contrary to common economic principles. This is all taking place at a time when much of the world is tightening monetary policy to combat rising inflation.

Country observers are forecasting a further cut or at most a hold, likely spelling more trouble for the Turkish lira and Turks’ cost of living.

Economists at London-based Capital Economics are forecasting a 100 basis point rate cut.

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“It is clear that the Turkish central bank is under political pressure to comply with Erdogan’s looser monetary policy and it is clear that Erdogan is more focused on growth in Turkey and not so much on fighting inflation,” said Liam Peach, a senior emerging market economist at Capital Economics, told CNBC.

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“While the Turkish central bank is under such pressure, we believe they may continue this rate-cutting cycle for another month or two…the window for rate cuts is small.”

Timothy Ash, emerging markets strategist at BlueBay Asset Management, also forecasts a 100 basis point cut. Erdoğan will not need any justification for this, said Ash, citing future elections as the reason for the step.

Meanwhile, analysts at investment bank MUFG are forecasting a hold at the current rate of 13%.

Economists are forecasting persistently high inflation and a further decline in the lira, which is already down 27% year-to-date and 53% against the dollar last year.

Erdogan, meanwhile, remains optimistic and predicts that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said in an interview on Tuesday. Erdogan is not a trained economist.

Referring to the impact of Erdogan’s decisions on the Turkish stock market, Ash said: “The risk of this unorthodox monetary policy is that it creates resource misallocation and bubbles that eventually burst, causing major risks to macro-financial stability.”

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