Central Bank warns about a hike in inflation by the end of 2011

The Central Bank sells $6.45 billion out of its moderate reserves in daily auctions since Aug 5 to defend the Turkish Lira. As a further effort, the bank also increases overnight lending rate to 12.5 percent from 9 percent. However, dollar sales, which have accelareted this week, are not sustainable, economists say

The Central Bank warns in a statement yesterday about a hike in inflation by the end of the year.The Turkish Central Bank’s already moderate foreign exchange reserves, which fell to $85.9 billion Turkish Liras as of Oct. 14 down from $93 billion at the end of July, signal a risky shrink as the bank continues to sell U.S. dollars in a bid to defend the value of the lira.

The figure announced by the bank yesterday comes after a big campaign of dollar sales that started this week. The Central Bank sold more than $1 billion in total on Oct. 18 in a direct intervention and a daily auction. It sold an additional $750 million of dollars in yesterday’s auction.

The bank has sold $6.45 billion since it started its daily forex auctions on Aug. 5.

Turkey may be forced to raise interest rates “aggressively” like Hungary did in 2008 because the Central Bank cannot sustain its sale of dollar reserves to prop up the lira, according to the European bank Societe Generale.

“Can the Central Bank sustain its intervention policy for a long time? The answer is no,” Benoit Anne, head of emerging-market strategy at Societe Generale in London, wrote in an emailed response to Bloomberg questions.

Overnight lending rate rises

Despite the growing pressure, the bank’s Monetary Policy Committee kept its rate unchanged but raised its overnight lending rate yesterday as it sought to prevent significantly higher inflation hitting the medium-term outlook, in moves that were seen as supporting the lira but hitting bonds.

After a monthly committee meeting, the bank said it widened the interest rate corridor, raising its overnight lending rate to 12.5 percent from 9 percent.

It held its policy rate, the one-week repo rate, unchanged at 5.75 percent, and kept its overnight borrowing rate at 5 percent. Analysts said the changes would make it more expensive to speculate against the lira.

“The decision of the Central Bank shows it will allow interbank rates to settle at a higher level. This will make it more costly to carry short lira positions. The increase of the overnight rates is negative for bonds, but it is positive for the lira,” said Finansbank economist İnan Demir.

The bank raised the interest rate on borrowing facilities provided for primary dealers via repo transactions to 12 from 8 percent. The lending rate for the late liquidity window was raised to 15.5 percent from 12 percent.

“We are still assessing the full impact of this decision, which concretely is monetary tightening, and the possible consequences in terms of future monetary policy mix, but at a first glance, the monetary policy committee resolution seems aimed at deterring short-term local speculators who borrowed on the overnight funds and bought dollars, betting on sustained lira weakness,” said a note by TD Rates and FX Research.

“In this respect, raising the cost of funding could effectively reduce the incentive to shorting the lira against the dollar. At the same time, the bank’s statement contained some innovative elements that suggest more of a long-term drift in their policy stance,” the note said.

The bank said inflation will rise significantly in coming months due to excessive lira depreciation, base effects from unprocessed food prices and hikes in administered prices.

“The committee will not allow these developments to have an adverse impact on medium-term inflation expectations and the inflation outlook,” it said, explaining reasons for hiking the lending rate.

HSBC strategist Fatih Keresteci said the move to widen the interest rate corridor was hawkish.

“The cost of borrowing will increase and those willing to open long speculative positions would have to bear the cost. This is a kind of hidden rate increase. I also think there can be aggressive intervention in the short term,” he said.

The bank’s moves gave a small boost to the lira, which firmed to 1.8580 from 1.8630 beforehand. The currency has lost some 17 percent of its value against the dollar this year.

October 20, 2011
SOURCE:  Hürriyet Daily News