Funding cost will be determined by the changes about the exchange rate, and thus the international risk appetite.

The Central Bank of Turkey (CBT) announced the second inflation report of 2012 with a press meeting. My impressions of the report and Governor Erdem Başçı’s presentation during the press meeting are as follows:

The CBT is going on with its multi-objective new monetary policy. Since late 2010, the Bank has been putting a special emphasis on three of these objectives: keeping the credit growth at a reasonable rate, easing “excessive” exchange rate impacts of short term FX capital inflows and outflows, and fighting with inflation. The second one was occasionally addressed in the context of current account deficit problem. The Bank, thus concentrates on inflation on the one hand and credit growth on the other, combined with the objective of controlling exchange rate short term capital inflows and current account deficit. From time to time, growth was underscored as a fourth element of the objective function, as well. 

Funding cost

To begin with, the CBT states that the rapid growth of the credit supply observed during 2010 and the first half of 2011 was eased and the pace of increase was reduced to the desired level.  Second, the Bank stresses that non-energy current account deficit has been decreasing substantially and that the share of long-term capital inflows in current account deficit finance has been increasing. The Bank underscores the positive role of the measures introduced in the context of the new monetary policy framework.

The Bank says that inflation has been floating significantly above the target and emphasizes the link with the developments during the second half of 2011. Stressed among these are hike of the exchange rate, the rise in energy prices and prices of certain public goods. The Bank maintains that such developments were reflected on the pricing behavior and wage negotiations affecting inflation expectations negatively and that these might push up inflation further. Therefore, the Bank argues, anti-inflationary measures came to the fore starting with October and that monetary policy was tightened in this context. Monetary tightening was carried out chiefly via daily increases in the “funding cost” corresponding to the interest on short-term loans to banks. The average value of the funding cost, the actual policy rate for the CBT, since November 29^th was 8.2 percent. The rate floated between 7 percent and 11.5 percent over the given period and it currently stands at 9 percent. 

Additional tightening

The CBT stresses that additional measures for monetary tightening are necessary and year-end CPI can be lowered to 6.5 percent only with additional measures. In addition, the Bank stresses, the policy rate needs to float as fluctuant risk appetite in the international markets causes extreme exchange rate volatility both upwards and downwards, which is not desired.

Concerning monetary policy dynamics, we must expect the following developments in the months ahead unless external conditions change drastically: first, the actual policy rate (that is, the funding cost) will remain at high levels as long as the upwards pressure on the exchange rate continues. In other words, the funding cost will more frequently go beyond 7 percent, which seems to be the lower limit so far. Second, the CBT will work to increase the value of lira slightly and efforts to this end will continue until the Bank makes sure that the year-end CPI converges to 6.5 percent. Spain is on the world agenda and interesting developments are due in France and Italy with elections on the horizon. Despite the fluctuations in risk appetite throughout the year, the external pressure on exchange rate appears to be upwards, unless the Fed makes a surprise decision. Under these circumstances, the CBT will stick to the flexible monetary policy and this flexibility will cause the actual policy rate float around a higher average. In short, the level of the funding cost will be determined by the changes about the exchange rate, and thus the international risk appetite.

This commentary was published in Radikal daily on 28.04.2012