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    To be on the safe side

    Fatih Özatay, PhD23 July 2013 - Okunma Sayısı: 932

    If the CBT raises its policy rate, this would mean it wants to keep interest rates at higher levels for at least a few quarters.

    It is a decisive moment for the Central Bank of Turkey (CBT). The Monetary Policy Committee convenes today. As those who keep tabs on will know, the CBT declares multiple interest rates. Three among these are of importance: the CBT’s overnight lending rate (the top-end of the interest rate corridor), the CBT’s overnight borrowing rate (the bottom-end of the interest rate corridor) and the policy rate within the corridor, i.e., the CBT’s weekly lending rate.

    Why are these rates important? Within the monetary policy framework in place until the late 2010, the policy rate was the most important one. The CBT had an objective to keep the short-term interbank borrowing rate close to its policy rate. It was keeping the borrowing rate in check by adjusting the level of liquidity injected into the market. The short-term interbank rate had an influence on longer-term rate on deposits, loans and securities.

    In some timeframes after the late 2010, another interest rate gained importance. By changing the width of the interest rate corridor, the CBT kept the short-term rate on interbank transactions at the desired level within the corridor on a daily basis, by lending to banks on different maturities. If it wanted the market rate up, it lent overnight more at the top-end of the corridor rather than at its lower policy rate. It also made lending on different maturities and at different interest rates.

    Experts from financial institutions now expect that the CBT will raise the top-end of the corridor. The main reason for the expectation was a short release by the CBT governor last week which read, “On its meeting on 23 July 2013 the monetary policy committee will put on the agenda a moderate step to widen the interest rate corridor.” An increase by 50 to 100 basis points is expected by some, while only a few economists expect an increase beyond this level. Currently the top-end of the corridor is 6.5 percent and is thus expected to be raised to 7 - 7.5 percent.

    Some of you might ask “the market rate is high above this level. Why should we care about the CBT raising the top-end?” After all, it was the US Federal Reserve’s (FED) remarks in June and early July that has shaken the markets. Later in July, FED Chairman gave remarks before the US Congress. Although the content was same as his previous remarks, his attitude and style relieved markets. In spite of this, the interest on Turkey’s most-traded Treasury bond floated around 8.9 percent as of Monday. This high rate despite the “sigh of relief” and deposit and loan rates starting to move up accordingly might justifiably make people question what difference it would make if the CBT raises the policy rate or not.

    But that’s not the case, exactly. Please note that if the CBT raises its policy rate, this would mean it wants to keep interest rates at higher levels for at least a few quarters. Raising the top-end of the interest rate corridor, on the other hand, just means that it might increase interest rates temporarily when deemed necessary. If this is not deemed necessary, the Bank might as well keep the average cost of lending to banks well below the top-end rate for a long timeframe. It might give a message to banks that there is no need to raise interest rates in the light of the available information. That’s why the committee’s decision about the top-end of the interest rate corridor is important. If the committee decides not to widen the corridor up, it will convey the message that the CBT does not seem any interest rate increase, even temporarily, necessary. I am not sure if markets will welcome such decision or not. Or more frankly, I should not be. Just to be on the safe side!

    This commentary was published in Radikal daily on 23.07.2013