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Having hiked its O/N lending rate by 50bp to 7.75% Tuesday, the Turkish central bank issued a statement Wednesday outlining further measures to shore up the lira. This all highlights the fact that Turkey is one of the most exposed EMs to deteriorating investor sentiment and that, for as long as pressures on EM currencies continue, the Bank is likely to remain in tightening mode.
The Bank's statement was brief, at only two lines, and doesn't give us much to go on. What it did tell us is that first, "additional monetary policy tightening will continue" every day until further notice. In effect, we think this means that the Bank won't provide liquidity via its benchmark one-week repo facility. Instead, banks will have to borrow via the O/N lending facility, which carries a higher interest rate. This will cause market interest rates to rise and should help to shore up capital inflows.
Second, the Bank stated that it will conduct FX sales (to purchase lira) of a minimum of $100mn per day.
These moves appear to have been triggered by the muted reaction in the market to yesterday's rate hike. Indeed, the lira continued to fall against the US$ this morning. However, we are cautious about how much impact the measures announced today will have. For a start, the Bank's ability to intervene in the FX market is constrained by its limited reserve coverage. FX reserves are only equivalent to around 75% of Turkey's short-term external debt. More generally, Turkey remains one of the most vulnerable EMs to deteriorating investor sentiment due to its large current account deficit (at 6.5% of GDP) and dependence on relatively volatile portfolio inflows.
The upshot is that, unless the pressure on EM currencies abates over the next few weeks, a further hike in the O/N lending rate looks likely at next month's MPC meeting (on 17th September).
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