WOOD Flash – Turkey macro: bold hikes, but with an eye for easing

The Monetary Policy Committee has raised the policy rate (one-week repo auction rate) to 24% (much higher than the consensus expectations of a hike up to 21%, in a range of 0-750bps). The move was all the more surprising as President Erdogan called once again for lower interest rates the morning before the rate decision. In our view, this move is a strong signal that President Erdogan is serious about avoiding a full-blown financial crisis and is probably also signalling that the lira above 6.5 vs. the USD is an unwelcome development, at least for the time being. Our assessment is that the forceful rate hike should help to increase the likelihood of rolling external debt in the coming year, together with the implicit support from Germany to alleviate some of the challenges posed by the threat of US sanctions and the FDI pledged by Qatar. Evidence of slower growth is already clear, in both real activity indicators and the balance of payments data, and, given the current level of the lira, we expect the current account deficit to shrink sharply in the next three quarters. In our view, a tighter fiscal stance is desirable at this juncture, to minimise the risk of more severe financial challenges next year. At this stage, the fiscal execution is not showing undue strain, and the budget deficit is on track to be close to 2% of GDP, but this is not a sustainable level once nominal GDP growth slows next year and if banks or publicly-owned companies require capital. The bold rate hike is likely to be a strong signal for investors, but we are not past the worst point for this correction. We maintain the view that the CBT is likely to aim to cut rates as soon as market conditions allow it – which, given the recent developments, may be around the spring next year.