Rebuilding credibility is always difficult-Commerzbank
Last Thursday, the Central Bank of Turkey (CBT) surprised the market by raising its main policy rate from 42.5 percent to 46.0 percent. At the same time, it raised the overnight lending rate to 49 percent and the overnight borrowing rate to 44.5 percent. Previously, we had envisaged that the CBT would try to avoid raising the main interest rate (in order not to anger President Tayyip Erdogan), which may be the reason why the CBT has resumed using its infamous 'interest rate corridor' after the volatility erupted following the detention of Istanbul Mayor Ekrem Imamoglu. But Tatha Ghose, FX analyst at Commerzbank (Commerzbank), noted that Thursday's decisive rate hike by the CBT dispelled those fears and bolster the credibility of the economic policy team.
Lira briefly recovers as market watches
The Turkish lira initially rebounded to its pre-existing 38.0 "line of defense" against the dollar. As we see in the chart below, the pattern of intraday movements changes when policymakers no longer need to use intervention to defend the exchange rate. The vertical line in the chart separates the pre-announcement period from the time since the rate hike-we can easily see a change in the volatility pattern, from a fully managed (flat) exchange rate line to a more free floating line; one might think that less aggressive intervention is needed when the exchange rate is able to appreciate on its own. Of course, things are reversing, and it remains to be seen what will happen in the future: one might assume that FX intervention will soon resume.
"Why is USD/TRY rising again? The answer is not obvious. The foreign exchange market is skeptical of something. One thing is obvious to us: the level of interest rates is not important at this point. When CBT started using the interest rate corridor again, we wrote that it made no difference whether the overnight lending rate was set at 46% or 50% or 60%. The complex corridor system is recalled, which is still an uncompromising disaster. We also now understand that the market's perception of CB credibility is a precious commodity that will take time to rebuild. Any flip at this stage of the rebuild will cause double damage.
"It remains to be seen how the credibility of CBT will develop in the eyes of the foreign exchange market, and in the future. The key is how long interest rates can last and how willing policymakers are to accept the economic soft patch needed to permanently reduce inflation. Unfortunately for CBT, the development of the past quarter has not been encouraging: CBT has become more complacent and interest rates have been cut too quickly. When there is no margin of insurance, we now see the inevitable result of having to turn around suddenly. USD/TRY We expect USD/TREY to gradually rise in the next quarter, waiting for policymakers to show more long-term caution.
