Turkey’s central bank cut interest rates by more than expected on Tuesday – a move that highlighted pressures from both far afield and closer to home.

In some ways, the further-flung-factor was the more straightfoward one: the inflationary stance of Japan’s new prime minister is having a significant impact on Turkish monetary policy. What is more controversial is the role of Turkey’s own premier.

It is hardly news to beyondbrics readers that this is an interconnected world where the international flow of funds is one of the biggest factors confronting emerging markets.

So it is unsurprising that Tokyo’s new, favourable stance on inflation has made itself felt in Istanbul and Ankara, increasing demand for Turkish lira-denominated assets that pay much higher rates than it costs to borrow in yen.

The spurt in this carry trade lies behind what the Turkish central bank described on Tuesday as a “re-acceleration in capital inflows”, a phenomenon that could drive the lira beyond comfortable levels at a time when authorities are trying to reorient the economy towards exports.

Recent favourable reports by both Moody’s and Standard & Poor’s on Turkey’s investment grade prospects may also have contributed to the inflow.

Hence the bank’s decision to cut rates across the board by 50 basis points – twice as much as the market expected – a move that reduced not just the official benchmark rate, now down to 5 per cent, but also the overnight lending and borrowing rates, down to 7 and 4 per cent respectively.

In an attempt to dampen the interest rate cuts’ impact on demand, the bank also nudged up its requirements on the reserves commercial banks must hold if they choose to keep foreign currency against lira deposits.

That, at least, is one way to view its moves.

Another, not necessarily contradictory, prism through which to view its action is simply to recall that Recep Tayyip Erdogan, Turkey’s powerful prime minister (pictured above), recently made abundantly clear his view that interest rates are too high.

The central bank’s independence is established by statute but on the other hand Erdogan wants to become Turkey’s first directly elected president next year – and last year’s 2.2 per cent growth was much lower than the electorate has become used to during his decade as prime minister.

But if the central bank kept even half an eye on the political pressure on it – Turkey’s economy minister and a portion of the country’s press are also insistent on the need for lower interest rates – it raises the question of whether the outward appearance of its move on Tuesday matches what actually happened.

Murat Ucer at GlobalSource Partners in Istanbul describes the rate cuts as a “doveish move supportive of growth”. He adds: “The bank is basically saying: “Slow down buddy” on the carry trade.”

Ucer argues that even though the bank’s accompanying statement makes confident noises about growth, this may be because raising concerns about growth prospects would open the bank open to unwelcome criticism.

But in one of the headsplitting acknowledgements that sporadically afflict analysts of Turkish monetary policy, he adds that the interest rate cuts do not necessarily mean that interest rates have come down.

The interest the real economy effectively pays largely depends not just on official rates but on how much money the central bank makes available and at what maturities, as well as a number of other manoeuvres. That is partly how the bank managed to all but double effective interest rates in 2011 while keeping the benchmark unchanged.

Indeed William Jackson of Capital Economics in London argues that in recent weeks the bank has effectively been tightening, not loosening, monetary conditions, with market interest rates rising by 100 basis points in that period before edging down in the few days.

The conclusion is this. When seeking to divine the concerns or motivations of the Turkish central bank, or those of other institutions in the country, it is important to look not so much at its statements as its actions. If you can work out what its actions actually are, that is.

Related reading:
What’s the script for Turkey? doing nicely, or could do better? beyondbrics
Turkish growth slows to lowest since 2009, FT
S&P brings Turkey within one notch of investment grade
, beyondbrics
Turkey: the central bank and conflicting signals
, beyondbrics

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