Turkeys central bank hints at rate increase as inflation rises

Turkeys central bank signalled it might be unable to maintain its much-criticised policy of keeping interest rates on hold after new data showed inflation rising to 17.9 per cent.The central bank said its monetary stance will be adjusted when its rate-setting committee meets next week. Inflation data released on Monday showed the annual increase of consumer prices approaching four times the official target in August.The bank warned that the inflation figures, which also showed that producer prices rose at an annual rate of 32.1 per cent in August, posed significant risks to price stability.The statement could mark a significant U-turn by the central bank, which has faced criticism that it was kowtowing to Recep Tayyip Erdogan, Turkeys president. Mr Erdogan has previously declared himself an enemy of high interestrates and vowed to use his authority to place his imprimatur on monetary policymaking. page 3of 4| template version MMXX.01Analysts warned that the bank would further undermine its wafer-thin credibility if it failed to follow Mondays announcement with a significant rise. Its statement comes just a month after it stunned international investors by refusing to raise rates despite the Turkish lira losing 40 per cent of its value against the dollar this year and inflation climbing far beyond its official 5 per cent target. In an interview with Reuters, Berat Albayrak, Mr Erdogans son-in-law and Turkeys new finance minister, reinforced the central banks statement, saying the country had reached the point where it needed a full-fledged fight against inflation. In the face of the currency sell-off and rising inflation, Turkeys monetary policymakers have declined to raise its main policy rate, the one-week repo, which stands at 17.75 per cent. Instead, the central bank and other government bodies have announced a series of technical measures viewed by the markets as insufficient.Some analysts were cautious about the central banks uncharacteristic intervention, warning there was still a strong chance of an insufficiently radical interest rate rise. Argentina, which has seen a similar currency sell-off in recent weeks, raised ratesto 60 per cent last week in an attempt to halt the slide in the peso. Piotr Matys, emerging market currency strategist at Rabobank, said the central banks announcement put pressure on it to deliver a proper rate increase. Governor [Murat] Cetinkaya raised the bar for himself to exceed market expectations at the time when there is no room to disappoint in the first place, Mr Matys wrote in a note to clients. page 4of 4| template version MMXX.01Jason Tuvey, an emerging markets economist at the consultancy Capital Economics, echoed that view. He predicted that pressure from the government would lead to a 2 per cent rate increase rather than the 7-10 per cent rise that he said markets wanted.The increase in consumer prices, which rose 2.3 per cent month on month, was driven by the surging cost of transport, which moved up 27 per cent year on year, as well as furnishing and household equipment, miscellaneous goods and services, and food and non-alcoholic drinks. The August figure, which follows July inflation of 15.85 per cent, was slightly higher than expectations. A Bloomberg survey of economists had put the predicted figure at 17.6 per cent. Separate figures showed that producer prices rose 6.6 per cent month on month in August. High inflation has helped fuel the depreciation of the lira, piling pressure on Turkeys indebted corporates. Over the weekend, a string of companies announced cash flow problems and missed debt payments.

Laura Pitelin Marmaris and Adam Samsonin LondonSEPTEMBER 3, 2018

Questions

1- Explain why inflation is such an important factor regarding nominal interest rates in Turkey.

2- Explain why the Turkish President would prefer if interest rates would remain low. (Remember that mentioned interest rates are for government bonds!)o

3- Explain why financial and economic experts argue that nominal interest rates in Turkey should be increased. Answer this question considering the formula for nominal interest rates,