Why did the CBT choose to cut the rate at fist and double almost double the rate and initiate FX selling auctions two months later?

On Tuesday I reiterated my opinion that the headline of the domestic economic policy in 2011 was the new monetary policy of the Central Bank of Turkey (CBT). On the very same day, the CBT shared with the public the monetary policy framework decided for 2012, as it has been doing since 2002. The framework does not differ much from the one that the Bank has implemented since August 2011. Today, I would like to address an unfortunate controversy in the report the Bank released. This controversy successfully summarizes why the monetary policy implemented throughout 2011 was extremely complex and confusing.

Paragraphs 7 and 8 say: “In August 2011 concerns regarding sovereign debt problems in some European economies and the global growth outlook have continued to intensify, increasing the tendency of risk aversion elevated and the volatility of risk appetite reached a historical high at the global scale... the Bank has delivered a measured policy rate cut to reduce the risk of a domestic recession that may be caused by the heightened problems in the global economy.” (refers to the interest rate cut by 50 basis points on August 4.)

Paragraph 9 says: “The rapid depreciation of the Turkish Lira along with the deterioration of global risk appetite in August and the adjustments in the last quarter on administered prices proved that short term increase in inflation will be stronger than envisaged. In order to prevent possible implications on medium-term inflation expectations and outlook, the Central Bank, adjusting the market funding, allowed the overnight market interest rate increase above the policy rate.”

Attention please: The direction of policy decisions and policy tools will naturally be changed when the circumstances change. That is, that you cut policy rate today does not prove a later increase wrong. We take our umbrellas with us only if it is raining, not in summer time, because circumstances change. However, it is quite weird to take completely opposite steps in response to same circumstances. Unfortunately, the CBT confesses that opposite steps were taken, during the above paragraphs and during paragraph 37 and 38.

Anyway, let’s cut it short: In August, concerns about the public debt aggravated across Europe and thus risk aversion gained prominence. At the same time, this trend became even more volatile. Then the CBT cut interest rates (paragraphs 7, 8 and 37). Paragraphs 9 and 38 also refer to the same circumstances: Appetite for risk aversion hiked starting with August. Lira devaluated, inflation elevated. Then the CBT allowed market interest rate to rise. How come!

Some of you might argue that the CBT had cut weekly policy rate and allowed overnight borrowing rate to hike. Still, the purpose of the policy rate is to influence overnight market borrowing rate and thus the interest on deposits and loans. In other words, it is the market rate that the CBT aims to influence via monetary policy, isn’t it? Thus, the outcome remains intact: the CBT first cut the interest rate and later after two months increased the rate back despite conditions remaining the same (rate cut on August 4 and increased on October 20).

If the CBT realized in August that risk aversion and uncertainties elevated, how could you not consider the impact of such tendencies on the exchange rate? Why did the CBT choose to cut the rate at fist and double almost double the rate and initiate FX selling auctions two months later? Yes, how come?

This commentary was published in Radikal daily on 29.12.2011