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The central bank has announced a new monetary policy framework and while the effective monetary policy stance remains unchanged today, but it is a strong signal that the central bank will be allowed more flexibility, explains Anders Svendsen, Research Analyst at Nordea Markets.

Key Quotes

“The CBRT has announced simplification of its monetary policy framework. A highly asymmetric corridor is replaced by a more conventional monetary policy framework with a repo rate and a symmetric overnight corridor.”

“The monetary policy stance has not been tightened today. The bank’s average cost of central bank funding%, which determines the market overnight rates, remains at 16.5%.”

“Still, Turkish leaders have taken another important step towards stabilising financial markets. By allowing the CBRT to simplify the monetary policy framework, President Erdogan sends a strong signal to the markets that the central bank has been given more flexibility to support the TRY and to get inflation under control.”

“The TRY is 3% stronger against the USD and the EUR today.”

“Looking ahead, the next monetary policy meeting 7 June will be crucial. The CBRT probably needs to hike rates again to reposition itself as a credible central bank with enough independence to bring inflation down to target. The market reaction in the coming days will show how much more the CBRT will have to do in terms of rate hikes to sell that story.”

“A key problem for the CBRT is the USD dependence of the Turkish economy, where non-financial companies are significantly net short USD. That means that the CBRT cannot see through the moods of the FX markets.”

The new framework

The CBRT will give enough liquidity on its 1-week repo auctions to keep O/N market rates close to the repo rate. That means that the repo rate will be the important rate. Intraday/week the O/N market rate will fluctuate within the overnight corridor of +/- 150bp. The late liquidity window will most likely not be an important source of liquidity for the banks. Until the new framework is phased in, the upper end of the corridor and the late liquidity lending rate will be 16.5%, which then remains the average cost of central bank funding.”