Jennison Market Review & Outlook 2021
Jennison shares their views on the current economic environment and outlook for 1Q 2021.
At the first meeting chaired by newly appointed Governor Naci Agbal, Turkey’s central bank (CBRT) materially simplified its policy apparatus and raised its one-week repo rate by 4.75 percentage points to 15%. The statement makes it clear that all central bank financing will henceforth be exclusively provided through the main policy rate, which is the one-week repo rate. Since the central bank used to provide financing through several, different windows, its effective cost of funding—the weighted average over the various instruments—was at 14.8% going into today’s decision. In effective terms, today’s tightening therefore amounts to a 20 bps increase in the policy rate, raising a question as to whether more tightening may be needed.
Although this observation does not diminish the considerable benefits of the swift and extensive streamlining of the policy apparatus that was achieved today, it nevertheless raises the question whether the recent tightening will prove sufficient to stabilize the lira and rein in the looming macro imbalances. The honest economist answer, as so often is the case, is “it depends.” Inflation has been sticky near 12%, and it risks increasing further from here, as today’s statement also acknowledges: “The lagged effects of depreciation in Turkish lira, increasing international food prices and deterioration in inflation expectations affect the inflation outlook adversely.” We see inflation likely increasing to 13% early next year and possibly going higher from there. As a result, FX deposits have been rising at a brisk pace as households attempted to hedge against considerable lira volatility (Figure 1).
The interest rate that banks pay on lira deposits ultimately drives households’ FX demand. Lira deposit rates are bound to rise from here, as they tend to closely follow the policy rate, shown in the Figure 2, given it is the average cost of central bank funding. Typically, dollarization has been reversed at real lira deposit rates of 3% or higher. Depending on the inflation trajectory, real rates may therefore fall short of what is needed to halt dollarization.
Going forward, the CBRT may have to tighten policy once more to maintain lira stability, once inflation rises early next year. To that end, today’s statement was unusually hawkish and suggests “… the tightness of monetary policy will be decisively sustained until a permanent fall in inflation is achieved.” Besides inflation, the statement also sets out benchmarks to assess likely improvements in the macro environment, suggesting: “The permanent establishment of a low inflation environment will affect macroeconomic and financial stability positively through the fall in country risk premium, reversal in the dollarization trend, accumulation of foreign exchange reserves and the perpetual decline in financing costs.” In other words, besides lowering inflation, the central bank is seeking a broad-based improvement in the relevant macro- and financial variables. So far, so good.
This material reflects the views of the author as of November 19, 2020 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
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