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Investors are bracing for a possible rate cut amid 80% inflation in Turkey

by SuperiorInvest

An electronic board displays exchange rate information at an exchange office in Istanbul, Turkey on Monday, August 29, 2022.

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Investors are bracing for another potential rate cut – or simply keeping the current rate unchanged – as Turkey refuses to follow economic orthodoxy in the fight against soaring inflation, which now stands at more than 80%.

Or indeed investors who can still stomach the volatility of the Turkish market.

The Eurasian hub of 84 million people, which still has many major banks in Europe and the Middle East and is highly exposed to geopolitical tensions, has seen major market turbulence in recent days, in addition to a dramatic drop in the exchange rate. last few years.

This week saw a big rout on Turkey’s stock market, Borsa Istanbul, with Turkish banking shares down 35% in the week ending last Monday, after a stratospheric 150% recovery from mid-July to mid-September. It prompted regulators and brokers to hold an emergency meeting, though they ultimately decided not to intervene in the market.

The cause of volatility? First, high inflation in Turkey has prompted investors to pour their money into stocks to protect the value of their assets. Analysts believe it was fears of higher US inflation and subsequent rate hikes by the Federal Reserve that likely triggered the sudden downward turn.

The decline wiped more than $12.1 billion in market value from the nation’s publicly traded banks.

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That’s because higher interest rates set by the US and the resulting stronger dollar spell trouble for emerging markets like Turkey, which import their energy supplies in dollars and have large dollar-denominated debts and will therefore have to pay more for them.

The market’s sharp decline prompted margin calls, which is when brokers demand that investors add money to their positions to cushion losses in stocks they bought on “margin” or borrow money. That caused another spiral of selling until Turkey’s main clearing house, Takasbank, announced on Tuesday an easing of collateral payment requirements for margin trading.

Banking stocks and the Borsa as a whole bounced back slightly after the news, with the bourse up 2.43% since Monday’s close as of 14:00 in Istanbul. Borsa Istanbul is still up 73.86% year-to-date.

Rising inflation: what next from the central bank?

But analysts say the stock market’s positive performance is not in line with Turkey’s economic reality as they look ahead to the Turkish central bank’s interest rate decision on Thursday.

Turkey is facing inflation just above 80%. shocked the markets in August with an interest rate cut of 100 basis points to 13% – in line with President Recep Tayyip Erdogan’s steadfast belief that interest rates will only increase inflation, contrary to widely held economic principles. All this is taking place at a time when much of the world is tightening monetary policy to combat soaring inflation.

Country watchers are predicting further cuts, or at most a hold, which likely spells more trouble for the Turkish lira and the cost of living for Turks.

Economists from London-based Capital Economics predict a rate cut of 100 basis points.

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“It is clear that the Turkish central bank is under political pressure to follow Erdogan’s looser monetary policy and it is clear that Erdogan is more focused on growth in Turkey and not so much on addressing inflation,” said Liam Peach, chief economist emerging markets. Capital Economics, told CNBC.

“While the Turkish central bank is under such pressure, we think that this cycle of interest rate cuts will continue for maybe another month or two… the rate cut window is small.”

Timothy Ash, emerging markets strategist at BlueBay Asset Management, also predicts a cut of 100 basis points. Erdogan won’t need to justify it, Ash said, citing future elections as the reason for the move.

Analysts at investment bank MUFG, meanwhile, predict the current rate will remain at 13%.

Economists predict continued high inflation and a further decline in the lira, which has already fallen 27% year-to-date against the dollar and 53% in the past year.

Erdogan, meanwhile, remains optimistic, predicting that inflation will fall by the end of the year. “Inflation is not an insurmountable economic threat. I’m an economist,” the president said during an interview Tuesday. Erdogan is not an economist by training.

Regarding the effect of Erdogan’s decisions on the Turkish stock market, Ash said: “The risk of these unorthodox monetary policies is that they will create misallocation of resources, bubbles that will eventually burst and cause major risks to macro-financial stability.”

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