Will the MPC reduce the policy rate? It might, by 0.25 points if it decided to cut the interest rate corridor. But it would be quite difficult to explain the grounds.

The Central Bank (CB) Monetary Policy Committee (MPC) will hold its April meeting today. Below is a summary of developments concerning the variables the CB targets.

Inflation: the current course is not harmonious with the inflation target. But there are two positive developments that are worth noting: first, the price of crude oil is decreasing towards $100, which is significantly below the average the CB takes as reference when making inflation estimations, currently at $108. In addition, annual CPI is expected to decrease in April due to a technical reason: CPI was quite high in April 2012 and the figure will be excluded off the calculation this year. This sure will lower annual CPI. Apart from these, the CB argues in several reports that the inflationary outlook is in fact in line with its targets. Hence, inflationary outlook will not play a major role in the MPC decisions.

Credit growth rate: Average credit growth rate was 21.7 percent in the first quarter. It is slightly higher for the last four weeks. Therefore, credit growth rate is stable above the 15 percent threshold.

Real effective exchange rate: the rate is 120, right on the reported threshold for intervention. The average value of the EUR/USD basket in March was 2.077 liras. In the first half of April, the rate decreased to 2.061 liras, indicating that lira appreciated nominally. Given the high inflation differential between Turkey and countries included in the calculation, real effective exchange rate probably exceeded 120 in April.

Growth: I have written a number of commentaries about the growth performance in the first quarter. There are mixed signals as to whether or not a moderate recovery started in the first quarter. But those indicating that recovery has started seem to become stronger.

Foreign capital inflows: After the Cyprus banking crisis, international risk appetite decreased in March, which lowered capital inflows to Turkey. But the mood of the markets settled as the latest figures suggest. Besides, the Bank of Japan announced a large quantitative easing. The latest positive assessment of Moody’s on Turkey is also worth noting. These, if not reversed, will accelerate fund inflows towards Turkey. The inflows will most probably be short and medium-term. Of course, uncertainties are still strong and prevailing. Italy is one example.

So, what are the options for the MPC? Assuming that no adverse development will take place until the meeting, I first expect increased liquidity injection to markets. In the previous meeting, the MPC decreased the funding through one-month repo auctions. This month the MPC will probably push funding up. Therefore, interbank market rate will get closer to the lower limit of the interest rate corridor. It is difficult to see beyond this point. In general, conditions are similar to what they were before the February meeting, after which the bank raised reserve requirements and cut the interest rate corridor. Due to the drop in capital inflows and the rise in volatility in March, however, the MPC switched back on the reserve option mechanism, ROM, and signaled a gradual increase in the reserve option coefficient.

Currently capital inflows are growing. As it followed an episode of decrease, however, this indicates that the volatility has sharpened. These, coupled with the current level of the real effective exchange rate, imply that the MPC will cut the lower limit of the interest rate corridor. Therefore, and also due to the gradual increase emphasis in the March meeting, the MPC might increase the ROM coefficients slightly. If it cuts the lower limit of the interest rate corridor, it might slightly increase reserve requirements.

Will the MPC reduce the policy rate? It might, by 0.25 points if it decided to cut the interest rate corridor. But it would be quite difficult to explain the grounds. So, this seems to be a very unlikely option. I do not have an estimation concerning the upper limit of the corridor.

This commentary was published in Radikal daily on 16.04.2013