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Further tightening was not the CBT's base case scenario and it will probably stick with this. However, room for a further increase in market ON rates is limited if the corridor remains intact. That could render the TRY vulnerable to global sentiment. If the downside pressure on the TRY continues to next week, a measured hike in the upper boundary of the interest rate corridor would not be a surprise.
We do not expect any change in the interest rate corridor (3.5%-7.25%) or the policy rate (4.5%) at the August 20 MPC meeting unless the currency depreciates further until then. The CBT is also likely to leave the reserve requirement ratio unchanged.
Inflation is likely to enjoy a visible drop in August and continue to decline in the rest of the year. Although the underlying inflation outlook is not very bright due to rising services inflation, the CBT is likely to gain time with the drop in the headline.
The outlook for loan growth is mixed. Aside from the acceleration before the end of the Ramadan holiday, there was a slowdown in the growth trend since the CBT's last meeting, along with the increase in interest rates charged on loans. The CBT may perceive the most recent pick-up in loan growth as a distortion due to the holiday and may not react.
Although it is hard to understand the CBT's FX rate sensitivity and the associated levels that would prompt the CBT's reaction, the volatility and FX rates are close to, but not above the July levels, which had forced the CBT to pre-announce its rate hike decision. The CBT may be encouraged to tackle the pressure with the current interest rate corridor.
The average cost of the funding that the CBT provides to the banking system via different channels has averaged to 6.0% since the July 23 MPC meeting and to 6.3% in August, implying some 120bps tightening since June. The current limits of the interest rate corridor would allow the CBT to lift the blended cost of funding to even above 7.25% by increasing the share of the one-month repo in the liquidity provision.
=So far we have summarized what we expect the CBT to do and the background motivation. However, this is not our favorite scenario. The ON repo rate at the BIST has been surfacing close to 6.5%, which would effectively be 7.3% once the reserve requirement is discounted. In other words, there is not much room for an additional increase in the ON rate, which has an important role in smoothing the TRY's volatility.
We believe that by not tightening further, the CBT would leave the TRY susceptible to the global interest rate outlook. If on the contrary, the CBT prefers to act swiftly this time, the uptrend in core global yields may bring forward the upward adjustment to the interest rate corridor that we expect in the coming months. That is to say, a measured hike in the upper boundary on Tuesday would not be a big surprise.
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