(Bloomberg) -- Turkey’s central bank said it’s focusing attention on a build-up of lira liquidity as it extended its interest-rate pause into a fourth month.
The Monetary Policy Committee, led by Governor Fatih Karahan, left the one-week repo rate at 50% on Tuesday, in line with the forecasts of all analysts surveyed by Bloomberg.
It repeated that the sterilization of liquidity “will be implemented effectively” with additional tools, with state media reporting that the authority is preparing to use foreign exchange and gold swaps to mop up excess liras.
Turkey’s 10-year lira government bonds rose, sending the yield down 28 basis points to 27.78% as of 4:16 p.m. in Istanbul. The Turkish currency was little changed after the rate announcement.
With official borrowing costs unlikely to rise further, policymakers have started to focus on the side effects of their efforts to replenish foreign-exchange reserves that resulted in billions of liras being pumped into the economy. The excess liquidity has been a drag on deposit rates and the cost of overnight funding, a worry for the central bank even after a turnaround in inflation in June.
The MPC also gave hawkish guidance on future moves, warning that monthly inflation “will rise temporarily” in July and vowing to maintain a tight stance until it sees a lasting slowdown in monthly price increases.
“In addition to the high level of and the stickiness in services inflation, inflation expectations, geopolitical risks, and food prices keep inflationary pressures alive,” the central bank said in a statement.
Consumer inflation slowed in June for the first time in eight months, but remains at over 14 times the official target of 5%. Karahan has tried to squash speculation of premature easing, saying he wants to ensure he can meet inflation goals beyond this year before discussing rate cuts.
More: Turkish Central Bank Head Wants to Banish Talk of Early Rate Cut
The governor said increases in electricity prices and taxes alone would add 1.5 percentage point to monthly inflation in July.
That prompted some analysts to revise their forecasts, with QNB Finansbank’s Erkin Isik predicting price increases will hit 4% this month. The central bank said the underlying trend in inflation would be little affected despite what it believes will be a short-lived pickup in July.
Annual inflation is still expected to slow from its current level of just under 72% due to the so-called base effect of comparing prices with the previous year’s rapid gains.
Turkey targets 14% inflation by the end of next year, while households see the figure at 71.5% in 12 months, a gap the central bank says is perpetuating a cycle of rising prices.
What Bloomberg Economics Says...
“The Turkish central bank’s decision to keep rates on hold is a sign of things to come — any threats to the inflation outlook will likely be addressed with tightening via alternative tools. We also expect the central bank to tackle the market’s ongoing lira oversupply with liquidity steps.”
— Selva Bahar Baziki, economist. Click here to read more.
The central bank’s latest view of liquidity included a tweak in the language that suggests it will be more “proactive” in controlling the lira oversupply, according to Orkun Godek, deputy general manager of strategy and research at Deniz Investment.
Policymakers said the situation is “assessed with respect to prospective developments and closely monitored.” The market’s lira abundance has turned the central bank into a net borrower via open-market operations continuously since July 12.
The monetary authority will lend additional foreign currency and gold to banks via swap auctions as part of its efforts to “sterilize” lira liquidity, state-run Anadolu Agency said, citing instructions sent to lenders.
The liquidity build-up is complicating the central bank’s efforts to keep financial conditions tight by dragging down deposit rates, which is the opposite of what officials want to achieve.
In response, policymakers have used sterilization tools to draw out excess liquidity from the market and support monetary tightening. The central bank’s net funding stood at negative 212 billion liras ($6.5 billion) as of July 22.
The rate decision followed Moody’s upgrade of Turkey’s credit rating by two notches last week — the first increase in 11 years — a decision it said was warranted by improved credibility in the central bank’s monetary policy. That left Turkey’s rating at B1, four levels below investment grade.
More: Turkey Wins Rating Upgrade from Moody’s After Over a Decade
Morgan Stanley said the upgrade might attract “higher quality” foreign inflows to Turkish assets, noting that lasting confidence in the currency would require a significant and sustained slowdown in inflation.
--With assistance from Joel Rinneby.
(Updates with state media report on lira liquidity steps in third and fourteenth paragraphs.)
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