Turkish central bank Governor Erdem Basci is finally laying to rest his policy of three interest rates, long after two of them ceased to hold any meaning to investors.
The bank may switch to a single benchmark this year, abandoning its policy of switching between targets. The lira inched higher after the announcement by Basci on Thursday - - and then fell within minutes as investors' attention returned to the worsening security situation and the Federal Reserve.
While his interest-rate corridor -flipping between a higher overnight and a lower weekly cost -- helped smooth out lira gyrations by warding off speculators in the policy's early days in 2012, it's had little relevance of late. That's because even the higher rate isn't enough for investors wary of Turkey's political risk at a time when the Fed is about to lift rates.
"Foreign investors can calculate weighted average market interest rates, but what they want to see is a stable, positive real interest rate leading into Fed tightening -- simple," Tatha Ghose, a London-based economist at Commerzbank AG, said by email Thursday. "When the central bank hikes this new benchmark by 150 basis points, as we forecast, then the lira will stabilize -- not because the policy definition changes."
Investors have become ever more cautious as political parties have yet to form a coalition government after last month's inconclusive elections even as the nation gets sucked into military conflicts in Syria and Iraq. Tensions have escalated since a suicide bomb blamed on Islamic State killed more than 30 people in a border town July 20.
The lira, which has tumbled 16 percent against the dollar this year, the third worst depreciation among major currencies, was poised for a recordlow close on Thursday after the death of three Turkish soldiers in the nation's southeast exacerbated concern over the country's peace process with Kurdish rebels.
The government's borrowing costs have jumped the most in emerging markets this year, with 10-year bond yields climbing 1.6 percentage points to 9.62 percent. Foreign investors sold a net $828.9 million of Turkish stocks and bonds in the week to July 24, the most in more than a month.
The central bank will seek to "find out what is the single, short-term interest rate that would allow us to maintain the same monetary policy stance we have now," Basci said in his statement. The current framework, which uses three separate interest rates ranging from 7.25 percent to 10.75 percent, was introduced to allow the central bank greater flexibility to respond to economic uncertainty, Basci said.
While the central bank has left its weekly rate, also known as the policy rate, unchanged since February, it's pushed up the average cost of funding for banks by changing the amount of credit it offers through repo operations. Banks' weighted average borrowing costs climbed to 8.60 percent yesterday, more than a percentage point above the policy rate.
Simplifying the regime will provide investors with more clarity and transparency, Phoenix Kalen, an emerging-market strategist at Societe Generale SA in London, said by e-mail on Thursday. But that still "may not be enough to override the more pressing and persistent negative dynamics regarding premature elections, escalation of regional geopolitics and Fedinduced capital outflows," she said.
The lira's weakness and accelerating inflation has brought the bank's easing cycle to an end after cutting the main one-week repurchase rate by a total of 75 basis points during the first two months of this year. Prices rose 7.2 percent in June from a year earlier, compared with bank's year-end target of 5 percent.
"The main problem with Turkey's monetary policy post-2008 was not unorthodoxy," Ercan Erguzel, Morgan Stanley's Istanbul-based economist, wrote in an e-mailed report Thursday. "It was low real policy rates. In other words, setting the level of a new single policy rate will be much more important than a simplified policy rate."