What’s the justification behind rate hike?
The Central Bank Monetary Policy Committee raised interest rates on late liquidity window borrowing by 75 basis points from 12.75 percent up to 13.50 percent. Because the Central Bank has been funding markets exclusively through the late liquidity window since November last year, 13.50 percent is naturally the average borrowing cost.
We haven’t witnessed such a steep rate hike for more than a year. The last increase in rates on average borrowing funding costs was 1.45 percent in February last year compared to January.
But what happened suddenly that the Central Bank needed to make such a steep hike?
When we look at the Monetary Policy Committee announcement made following its meeting on April 25, the only justification given is the increase in import prices. The reason listed in the previous statement for the necessity of raising rates - high core inflation - is not mentioned. But that may be understandable: risks caused by import prices naturally include core inflation as well.
The latest consumer price index (CPI) released by the Turkish Statistical Office (TurkStat) shows a price increase in March of 10.23 percent. The average borrowing cost in March was 12.75 percent, so there is a gap of 2.52 percentage points. The gap looks set to widen even more with the rate hike to 13.50 percent.
W den ng nflat on rate gap
Speaking of which, annual CPI indeed reveals the inflation rate of the past 12 months, but as the funding given through the late liquidity window is due in one day, we actually have to look at the previous annual CPI change. Therefore, we can’t compare the average funding cost with the expected inflation for the upcoming 12 months.
We can’t know where inflation will be by the end of April and May. But if all goes normally, annual inflation is expected to be between 10 and 10.50 percent.
At a time when annual inflation is increasing, why would the central bank increase borrowing costs up to 13.50 percent?
Naturally, the Central Bank has more information regarding inflation trends. Therefore, the rate hike should be considered a signal that inflation will climb upwards in the coming months.
So, even though it seems that the gap between rates and inflation has widened, the expectation is that it will again narrow as inflation goes up.
But what if inflation does not go up? How then will we justify this latest rate hike?