Turkey Has a Massively Important Decision to Make on January 24th

Domestic factors pointing to a rate hike

The Central Bank of Turkey will meet on January 24 to decide on monetary policy. It will be under tremendous pressure to raise interest rates, and most likely will do so, though the path is not as straight forward as it may seem.

We’ve seen earlier in this series how the increase in Turkey’s current account deficit is putting downward pressure on the lira. The high level of inflation is exerting similar influence on the currency.

The way the central bank can arrest a further decline in the lira is by hiking interest rates, an action which theoretically puts upward pressure on the home currency. However, this is where things get complicated for the central bank.

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Economic growth will get hurt

A rise in interest rates, one of contractionary monetary policy, can help strengthen the lira and also put a lid on inflation. But at the same time, it will check economic growth and worsen the labor market situation. Moreover, it will make credit more expensive, something that the government does not want.

Ideally, the actions of a central bank should not be influenced by the government. However, this does not seem to be the case in Turkey.

Several times in the past, President Recep Tayyip Erdoğan has expressed his desire for lower interest rates which make cheap credit available and assists in economic growth. The central bank governor, Murat Cetinkaya, has agreed with the President for the most part as only small increases have been effected on the back of the general trend of rate cuts.

This interference in the policy decisions of the central bank can prove to be disastrous as Turkey runs the risk of hyperinflation. Even more urgently, if the bank takes no rate action in its upcoming meeting, then it risks further downward pressure on the lira. No action would also send the message that political influence is directing monetary policy, thus hurting investor confidence and resulting in further outflows from the country.

Investors in Turkish equities (TUR) can consider reducing their exposure due to the fact that the situation in Turkey is far from stable – both politically and economically. They should also brace for a rate hike as supporting the lira seems to be a more pressing need than stimulating the economy at this juncture.

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