Higher interest rates do not fit with Turkey’s growth strategy – ABN Amro

Nore Neuteboom, an economist at ABN Amro, argues that the Turkish central bank is going hold its policy rates steady on July 24 and adds that higher interest rates would not fit with Turkey’s growth strategy.

Key quotes

“The central bank communication on 24 July will be an important signal to the markets. Will the monetary policy committee, despite political pressure, increase interest rates? The independence of the central bank has been questioned before. But they did what they had to do (albeit somewhat late) by hiking 500bp since April to the current level of 17.75%. Investors hope that 24 July will not be different. The market is pricing in a sizable interest rate hike, 100bp. We are not convinced that the central bank will act. Given the tight grip of ErdoÄŸan on the central bank and as higher interest rates do not  fit with Turkey’s economic growth strategy, we expect the Turkish central bank to keep the one-week repo rate on hold at the monetary policy meeting on 24 July.”

“One of the problems ErdoÄŸan faces is that high inflation is eroding household incomes. As inflation is much higher than wage growth, at 11.6% vs 7.5% respectively, households do not benefit from the economic growth strategy. The savings rate is low in Turkey and spending power will decline even further.”

“Furthermore, keeping rates on hold will result in another sharp depreciation of the lira. The current account deficit is pushing towards 6.5%, and Turkey’s annual external financing requirement – reflecting the current account deficit and maturing debt – sits at USD218bn and will increase to USD240bn this year according to the IIF (28% of GDP). Therefore, the risk of an external debt crisis will increase further (see also: Turkey Watch: Turkey in crisis) and we will continue to see higher inflation on the back of higher import costs.”