Investors brace for potential rate cut amid 80% inflation in Turkey

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

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Investors are bracing for another possible interest rate cut, or simply to keep the current rate, as Turkey refuses to follow economic orthodoxy to fight its runaway inflation, now at more than 80%.

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

The Eurasian hub of 84 million people, to which many major banks in Europe and the Middle East still have considerable exposure and which is highly exposed to geopolitical tensions, has seen major market turmoil in recent days, in addition to the dramatic falls of the currency in recent years.

This week saw a big drop in Turkey’s stock market, the Istanbul Stock Exchange, with Turkish bank shares falling 35% for the week ending last Monday, after posting a stratospheric rally of 150% between mid-July and mid-September. It prompted regulators and brokers to hold an emergency meeting, though they ultimately decided not to intervene in the market.

The cause of the volatility? First, Turkey’s high inflation had pushed investors to put their money in stocks to protect the value of their assets. But it was fears of higher US inflation and subsequent rate hikes by the Federal Reserve that likely triggered the sudden downward turn, analysts believe.

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

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This is because higher interest rates set by the US and a resulting stronger dollar spell trouble for emerging markets like Turkey, which import their energy supplies in dollars and have large dollar-denominated debts, and therefore they will have to pay more for them.

The market crash triggered margin calls, which is when brokerages require investors to add money to their positions to cushion losses on stocks they bought on “margin” or borrowed money. That sent sales soaring even higher, until Turkey’s main clearinghouse, Takasbank, announced on Tuesday an easing of requirements for collateral payments in margin trading.

Bank stocks and the stock market as a whole rallied slightly on the news, with the stock up 2.43% from Monday’s close at 2pm in Istanbul. The Borsa Istanbul continues to rise 73.86% so far this year.

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But analysts say the positive stock market performance is not in line with Turkey’s economic reality as they await the Turkish central bank’s interest rate decision on Thursday.

Faced with inflation of just over 80%, Turkey shocked markets in august with a 100 basis point interest rate cut to 13%, upholding President Recep Tayyip Erdogan’s firm belief that interest rates will only increase inflation, contrary to widely accepted economic principles. All of this comes at a time when much of the world is tightening monetary policy to combat runaway inflation.

Country watchers are forecasting another cut, or at most a hold, which is likely to spell more trouble for the Turkish lira and for the cost of living for Turks.

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

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“It is clear that the Turkish central bank is under political pressure to abide by Erdogan’s looser monetary policy, and it is clear that Erdogan is more focused on Turkey’s growth and not so much on tackling inflation,” said Liam Peach, Senior Economist. of emerging markets from Capital Economics, he told CNBC.

“While the Turkish central bank is under so much pressure, we think it will continue this rate-cutting cycle for another month or two…the window to cut rates is small.”

Timothy Ash, emerging markets strategist at BlueBay Asset Management, also predicts a 100 basis point cut. Erdogan will not need a justification for this, Ash said, citing future elections as the reason behind the move.

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

Economists forecast continued high inflation and a further decline in the lira, which has already fallen 27% against the dollar so far this year, and 53% in the past year.

Meanwhile, Erdogan remains optimistic, forecasting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview Tuesday. Erdogan is not an economist by training.

Regarding the effect of Erdogan’s decisions on the Turkish stock market, Ash said: “The risk of these unorthodox monetary policies is that they create resource misallocation, bubbles, which eventually burst, causing big risks to macro stability. financial”.

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