Turkey central bank avoids rate hike pledge in nod to Erdoğan

Turkish central bank governor Şahap Kavcıoğlu avoided making a pledge to raise interest rates if needed on Thursday even as he increased a year-end estimate for inflation substantially.

The bank will maintain tight monetary policy “with great decisiveness and patience” and keep interest rates at above inflation, Kavcıoğlu said during an online presentation of the bank’s quarterly inflation report.

“We are watching the market and the market is watching us,” Kavcıoğlu said amid persistent questions from economists on the direction of interest rates.

President Recep Tayyip Erdoğan’s brought in Kavcıoğlu in mid-March, sacking former finance minister Naci Ağbal as governor after he hiked interest rates to 19 percent from 17 percent. Kavcıoğlu’s arrival has caused a sell-off in the lira on concern that the central bank will cut interest rates and undermine the battle against inflation under his watch. Annual price increases in Turkey hit 16.2 percent in March, the highest level in major emerging markets outside of crisis-hit Argentina.

Before his appointment, Kavcıoğlu, the third central bank governor in less than three years, sympathised with Erdoğan’s insistence that high interest rates cause inflation, a view that contradicts with conventional economic theory. He said last week that high borrowing costs hurt industry.

Kavcıoğlu avoided answering a question about whether he could persuade Erdoğan that rate hikes were needed, in a Q&A session following the presentation. An official moderating the online meeting sought to interrupt the questioner when Erdoğan’s name was mentioned. Kavcıoğlu appeared to answer questions from economists and journalists with a pre-prepared text.

The lira was little changed at 8.19 per dollar in afternoon trading in Istanbul. It has fallen by 15 percent since Ağbal’s dismissal. Currency weakness typically pressures inflation with a lag by making imports of goods, materials and services more expensive.

Economists expect inflation to accelerate in April and May to near the bank’s benchmark interest rate, which it kept on hold at a meeting of its Monetary Policy Committee (MPC) on April 15. Kavcıoğlu said that he saw inflation peaking at 17 percent in April before a slowdown gathered pace in the second half of the year.

“It is clear here that Kavcıoğlu does not think he will have to hike rates,” said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. “I guess he is hoping that inflation does not hit 19 percent, so he does not have to deliver on his promise of positive real rates.”

The governor said a decision by the central bank to erase a written pledge to further tighten monetary policy if needed from a monthly summary of its MPC meeting for April did not mean that the bank was abandoning its tight stance.

He said a commitment to keep rates at a defined margin above inflation provided greater clarity on policy. He declined to say what that margin would be and whether interest rates could be raised.

Kavcıoğlu said the bank increased its estimate for year-end inflation to 12.2 percent from a previous 9.4 percent, citing declines in the lira and higher import prices. It hiked the forecast for the end of 2022 to 7.5 percent from 7 percent.

The governor said economic activity was strong and loans provided by banks were increasing. The situation could reverse due to the pandemic and depressed markets for exports in Europe, he said. Food price inflation, which has surged in recent months, will probably end the year at 13 percent, he said, revising the bank's estimate from 11.5 percent.

The MPC next meets on interest rates on May 6, three days after the Turkish Statistical Institute announces April inflation figures.

(This story was updated with lira price in seventh paragraph, governor's comments in the 12th and 13th.)

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