As it is declared that additional monetary tightening might be implemented more frequently, ‘the real policy rate’ might exceed 7 percent.

The Monetary Policy Committee (MPC) had a routine meeting yesterday. Here is the first important thing to quote from the decision: “...the MPC has decided to keep the short term interest rates constant at the following levels: a) One-week repo rate (the policy rate) at 5.75 percent...” All MPC decisions cite the one-week repo rate as the policy rate. The rate has been standing at 5.75 percent since 4 August 2011. In other key documents, the inflation report for instance, the Central Bank (CBT) stresses that the monetary policy has been tightened significantly since October. Given the rate that the CBT considers as the policy rate is constant since 4 August 2011, how the CBT can be tightening the monetary policy since October 2011?

This is “odd”
I think it is clear that this is impossible. This “odd” situation arises from the fact that the CBT does not declare clearly what the real policy rate is.

Here is how the CBT explains the method of monetary tightening in the second page of the latest inflation report: “...the CBRT has delivered an important tightening in monetary policy since October. Accordingly, the interest rate corridor was widened upwards and the average funding cost was raised significantly by adjusting the amount of TL funding through 1-week repo auctions, when deemed necessary.”

As I have tried to stress during the last two commentaries, the real policy rate for the CBT is the “funding cost.” Then, it should be what markets actually have to focus on. But there is one problem: The CBT has been changing this real policy rate almost on a daily basis since 29 November 2011. The rate has been floating between 7 percent and 11.9 percent since then. In other words, there exists major uncertainty about the level of this real policy rate.

Therefore, the upper and the lower limits of the interest rate corridor that determines the upper and lower boundary of the policy rate, become much more important for markets. The overnight lending rate at 11.5 percent and the overnight borrowing rate at 5 percent constitute the upper and the lower limits of the interest rate corridor. Therefore, possible changes in the limits might be of importance. Raising the lower limit, for example, the CBT signals that it might soon raise the “funding cost”, the real policy rate, further.

The meeting yesterday did not deliver any changes in the lower and upper limits. But the decision said, “...inflation may hover above the envisaged path in the short term due to hikes in energy prices. The Committee will not tolerate temporary factors to have an adverse impact on the inflation outlook. Accordingly, it was underscored that additional monetary tightening may be implemented more frequently in the forthcoming period.

The Committee stated that, given the prevailing uncertainties regarding the global economy, it would be appropriate to preserve the flexibility of the monetary policy. Therefore, the impact of the measures undertaken on credit, domestic demand, and inflation expectations will be monitored closely and the funding amount will be adjusted in either direction, as needed.”

In brief, the CBT says “though I have not changed the rate that I call the policy rate, I might change the ‘real policy rate’ when necessary.” As it is declared that additional monetary tightening might be implemented more frequently, ‘the real policy rate’ also will exceed 7 percent more frequently.

This commentary was published in Radikal daily on 19.04.2012