At its latest rates setting meeting this week, the Central Bank of Republic of Turkey kept rates unchanged as expected, though the market was taken by surprise as the CBRT announces new monetary policy framework. At its May meeting the CBRT announced it was simplifying its monetary policy framework where its highly asymmetric corridor will now be replaced by the more conventional framework of a repo rate and symmetric overnight corridor.
This represents the latest in a series of moves designed to help stabilise Turkish financial markets which have undergone significant volatility in recent years. Through allowing the CBRT the freedom to make such a move, President Erdogan has given the market a strong signal that the he is in favour of affording the CBRT flexibility and autonomy in order to support TRY and help get inflation back to target.
It is worth noting, however, that the CBRT has tried such a move in the past. In 2016 the bank reduced the upper-end of its overnight corridor seven times by 250 basis points in a bid to create a symmetric corridor, only to then hike rates following the US presidential election and introduce an asymmetric corridor the following month.
One of the big issues facing the CBRT is how dependent the Turkish economy is on the US Dollar, as many non-financial companies hold large net short USD positions. This makes it difficult for the CBRT to gain perspective on the financial securities market in the same way that a country such as South Africa can. If the CBRT needs to adjust all rates in order to stabilise TRY, the broader economy will feel the impact, hence the need for the asymmetric corridor. The CBRT will therefore need to prove that curbing FX market volatility is a higher priority than the consequent increase in domestic interest rate volatility.
Understanding the New Framework
The CBRT will now offer enough liquidity on its 1-week repo auctions to keep overnight market rates close to the repo rate. What this means is that the repo rate will be the most important rate of the two. On an intraday/week basis, the overnight market rate will fluctuate within the overnight corridor of +/- 150 basis points. The late liquidity window will likely not be a key source of liquidity for the banks.
Until such time as the new framework is fully implemented, the upper end of the corridor and the late liquidity lending rate will remain at 16.5% which will be the average cost of central bank funding.
USDTRY continues to soar to fresh highs on the year pushing up to a record high last week before softening this week. The pullback in USDTRY is a welcome sign for TRY bulls though while above the key 3.94 – 3.98 region support zone, any dips are likely to see buying kick in from longer term players. Until such time as the aforementioned support level is broken (which also holds the 61.8% retracement from 2017 lows) the focus remains on further upside. However it is possible that we see some stagnation and consolidation now over summer.