By Ali Kucukgocmen and Ece Toksabay
ANKARA (Reuters) -Turkey’s central bank kept its policy rate at 8.5% on Thursday as expected, holding steady for a third straight month, despite a market rout after the first round of elections which indicated President Tayyip Erdogan was poised to win in the runoff.
After Erdogan’s solid lead in the May 14 vote became clear, the lira has tumbled to record lows and Turkey’s sovereign dollar bonds and equities have plunged, while the cost of insuring exposure to Turkish debt has spiked.
But the central bank did not mention any of these moves on Thursday, and instead said the underlying trend of inflation continued to improve.
“It has become even more important to keep financial conditions supportive to preserve the growth momentum in industrial production and the positive trend in employment,” the bank said after its monthly policy meeting.
Economists expect annual inflation, which declined to 43.7% in April from a peak of 85.5% last year, to rise again in the coming months. But they expected the central bank to keep rates on hold this month in line with Erdogan’s unorthodox policies that call for low rates.
Nicholas Farr, emerging Europe economist at Capital Economics, said Erdogan’s expected victory on Sunday makes the likelihood of “much-needed” rate hikes low.
“Turkey’s economy is in desperate need of much higher interest rates and a shift away from the current policy framework to tackle its large macro-imbalances,” he said in a note.
Authorities can only use “distortionary policies” for so long to keep the lira stable if Erdogan wins and “a sharp depreciation in the currency is only a matter of time”, Farr said.
DEPLETED RESERVES
The lira touched a fresh record low of 19.9325 nearly an hour after the central bank decision, before recouping some losses.
The central bank’s net forex reserves also dropped to negative territory for the first time since 2002, standing at minus $151.3 million on May 19, in another sign of the pressure the economy faces due to the unorthodox policies.
After years of market interventions and other methods to cool forex demand, the latest drop came as forex demand surged ahead of elections on May 14 on expectations that the lira would plunge after the vote.
Selva Demiralp, economics professor at Koc University and former economist at the U.S. Federal Reserve Board, said authorities would have to compromise on growth targets if they continue to suppress forex demand.
“The timeframe of how long FX can last depends on authorities’ ability to find FX supply and their ability to suppress FX demand,” she said.
“The remaining alternative would be stricter capital controls,” Demiralp said, adding that Turkey is “not that far” from such measures.
POLICY REVERSAL?
The bank last cut its main interest rate by 50 basis points in February to provide stimulus after earthquakes which killed more than 50,000 people in Turkey and caused extensive destruction across ten provinces.
Last year the central bank cut its key rate by 500 basis points in an unorthodox easing cycle designed to counter an economic slowdown, before keeping it steady at 9% in December and January.
The unorthodox cuts, which were part of Erdogan’s plan, led to a currency crisis and sent inflation soaring. With foreign reserves tumbling, some analysts say Turkey could face another economic crash soon.
Erdogan came out comfortably ahead of opposition leader Kemal Kilicdaroglu in the first round of the presidential election but fell just short of the more than 50% support needed to avoid this Sunday’s runoff.
The presidential election could change the path of monetary policy, making it difficult for many economists to forecast a year-end policy rate in the Reuters poll.
There is disagreement and uncertainty within Erdogan’s government over whether to stick with what some call an unsustainable economic programme or to abandon it, insiders say.
Kilicdaroglu’s opposition alliance has also pledged to reverse Erdogan’s programme with aggressive rate hikes.
(Reporting by Ali Kucukgocmen and Ece Toksabay;Additional reporting by Jonathan Spicer;Editing by Daren Butler and Nick Macfie)
