‘Enemy’ Of Interest Rates Tempts Fate. Again

In yet another exceptionally ill-advised, albeit wholly predictable, move, Turkey cut rates again on Thursday.

The lira responded accordingly, falling to yet another fresh record low (figure below).

The latest chapter in what can only be described as a comically ridiculous saga came just a week after Recep Tayyip Erdogan purged three central bank officials deemed insufficiently convinced that the strongman’s “unorthodox” (an absurd euphemism) views on rates, FX and inflation are viable.

The annotations in the figure (above) mark notable moments in the recent evolution of monetary policy under Erdogan.

CBT governor Sahap Kavcioglu, who replaced the hawkish Naci Agbal in March, kept rates unchanged for his first five meetings. But Erdogan’s insistence on lowering borrowing costs while simultaneously bringing down inflation meant it was just a matter of time before the central bank was forced into another rate cut on the (silly) premise that easing policy would ameliorate price pressures in an emerging market which has lost virtually all credibility when it comes to central bank independence.

What Erdogan wants, Erdogan generally gets. So, Kavcioglu obliged and cut rates last month. Then, he did it again on Thursday.

Read more: Meanwhile, In Turkey

Last month’s cut “surprised” the market. The scare quotes around “surprised” suggest no one should have been taken aback. Even if you knew nothing at all about Erdogan and thus weren’t apprised of the extent to which long periods of tight policy are basically illegal, Kavcioglu essentially pre-announced the move weeks beforehand when he shifted the central bank’s focus to core inflation, which removes food. Happily, core is much lower than headline inflation.

Just in case the situation wasn’t farcical enough already, October’s cut was twice as large as expected. The implied real rate in Turkey is now near -4% (figure below).

Inflation ran at 19.58% in September. Core was 17%, which means even if you use Kavcioglu’s preferred gauge (which, again, served as the excuse for last month’s cut), real rates are still negative. Thursday’s 200bps cut took the policy rate down to 16% (figure below).

At some point, this will be a crisis. Or maybe not. This plays out the same way almost every, single time.

Erdogan pushes things to the absolute breaking point, then makes minor concessions on multiple fronts (usually by giving the central bank leeway to take real steps aimed at arresting the currency’s slide while simultaneously adopting a more conciliatory tone towards whatever geopolitical spat is weighing on sentiment) to restore a semblance of confidence.

Analysts were fatalistic on Thursday. Bloomberg quoted Piotr Matys. “[Kavcioglu’s cut] can be interpreted as a very strong message to market participants that the central bank intends to ease monetary policy regardless of negative consequences of the precipitous fall in the value of the lira.”

The same linked article contained a delightfully dry summary from Cagan Koc, who covers Turkey. “A self-described ‘enemy’ of high interest rates, Erdogan espouses the unconventional hypothesis that reducing them will lead to lower inflation.”