The Turkish lira fell on Tuesday as Turkey’s central bank unexpectedly cut its overnight lending rates and issued a more dovish assessment of global monetary conditions.
The central bank said in a statement that it had cut its overnight lending rate to 11.5% from 12.5%, in a move that was congruent with loosening global liquidity. The bank held its key policy rate at a record low and kept its overnight borrowing rate steady, at 5.75% and 5% respectively, in line with market expectations.
The cut in the overnight lending rates means a lower ceiling for the bank’s flexible interest rate corridor policy, which enables the monetary policy committee to shift interest rates according to monetary conditions.
The technical loosening sent Turkish assets lower. The lira extended its losses, falling 0.6% against the dollar to trade at 1.7500 early in the European afternoon. Bonds weakened, while stocks stayed in negative territory.
Economists said the decision indicated that the bank wanted to put downward pressure on the fast-rising lira and was confident it could continue to attract capital inflows with a lower interest rate.
“This is probably related to the lira’s appreciation more than anything else,” said Sengul Dagdeviren, chief Turkey economist for the Turkey operations of Dutch bank ING. “We see this as no major change in current market rates but more a signal looking forward where the central bank says if capital inflows continue to strengthen they might continue to revert the tightening.”
Before Tuesday’s decision, analysts had expected no change in the bank’s key interest rates, but speculated that policy makers were becoming increasingly uncomfortable at the rapid strengthening of the lira this year.
The lira has risen some 7% against the dollar since the beginning of the year, making it one of the world’s most rapidly appreciating currencies. But policy makers have expressed concern that a rapid strengthening could make Turkey’s exports less competitive.
The contents of the central bank’s statement accompanying the policy decision struck a less hawkish tone than in recent months, stressing that policy should be “cautious” rather than “tight.”
The move to loosen policy, in part to put downward pressure on the lira, marks quite a turnaround for Turkey’s central bank. In December Governor Basci was battling to support the lira as it touched 1.9205, a record low against the dollar. The lira was under pressure as markets tested policy makers’ resolve to defend the currency amid deteriorating global sentiment and heightened nerves about Turkey’s widening imbalances.
To support the lira, the monetary policy committee in December launched a large-scale intervention for only the second time in five years and followed that move with four consecutive interventions of around $4.5 billion, according to traders.
Those moves, alongside daily foreign exchange auctions, saw the bank’s reserves fall from a peak of $94 billion to the current level of $77 billion, fueling market concerns that the lira was vulnerable to a broad sell off.
After shoring up the currency, Turkey’s central bank governor in January boasted that the lira would be “one of the currencies gaining the most in 2012,” and would “continue to appreciate this year because the central bank will let it appreciate.”
Economists cautioned that the policy impact on the lira could be negligible since the central bank has already been funding the market at the lower end of its rate corridor, rather than at the ceiling.
Morgan Stanley said in a research note that the move amounted to “a rate cut but no easing.”
“Even on the currency front, the overall impact might be limited because the CBT has already been funding the market (local banks) at much lower rates,” said Tevfik Aksoy, Morgan Stanley economist.