Investors are preparing for a possible rate cut due to inflation of 80% in Turkey

An electronic whiteboard displays exchange rate information at a currency exchange office in Istanbul, Turkey on Monday, August 29, 2022.

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Investors are bracing for another potential interest rate cut – or simply a freeze on the current rate – as Turkey refuses to follow economic orthodoxy in the fight against its soaring inflation, which now exceeds 80%.

Or even, investors who can still bear the volatility of the Turkish market.

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The Eurasian hub of 84 million people – to which many large banks in Europe and the Middle East still have considerable exposure and which is highly exposed to geopolitical tensions – has seen severe market turbulence in recent days, as well as dramatic declines. currencies in recent years.

This week saw a major defeat in the Turkish stock market, the Istanbul Stock Exchange, with Turkish banking stocks down 35% during the week ending last Monday, after posting a stratospheric 150% rally between mid-July and mid-September. It prompted regulators and brokers to hold an emergency meeting, even though they ultimately decided not to intervene in the market.

The cause of the volatility? First, Turkey’s high inflation had prompted investors to pour their money into stocks to protect the value of their assets. But it was the fear of higher inflation in the US, and the resulting rate hike by the Federal Reserve, that likely triggered the sudden downturn, analysts believe.

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

Russian tourists to Europe dropped dramatically over the summer, but increased in many other destinations, including Turkey (here).

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This is because the higher interest rates set by the US and the resulting stronger dollar create problems for emerging markets like Turkey which import their energy supplies in dollars and have large dollar-denominated debt, and therefore will have to pay more for it. these.

The fall in the market has resulted in margin calls, which is when brokers require investors to add money to their positions to amortize losses in stocks they bought on “margin” or borrowed money. This caused a further spiral of sales, until Turkey’s main clearing house, Takasbank, announced on Tuesday an easing of the requirements for collateral payments on margin trading.

Banking stocks and the stock market as a whole rebounded slightly on the news, with the stock market up 2.43% from Monday’s close at 2pm in Istanbul. The Istanbul stock market is still up by 73.86% from the beginning of the year.

Soaring inflation: and then from the central bank?

But analysts say the exchange’s positive performance is out of line with Turkey’s economic reality as they look forward to the Turkish central bank’s interest rate decision on Thursday.

Faced with inflation of just over 80%, Turkey shocked markets in August with an interest rate cut of 100 basis points to 13%, sticking to President Recep Tayyip Erdogan’s firm belief that interest rates interest will only increase inflation, contrary to widely held economic principles. All of this is happening at a time when much of the world is tightening monetary policy to combat rising inflation.

National observers expect another cut, or at most a suspension, which will likely mean more problems for the Turkish lira and the cost of living for the Turks.

Economists at London-based Capital Economics are predicting a rate cut of 100 basis points.

“It is clear that the Turkish central bank is under political pressure to stick to Erdogan’s more accommodative monetary policy, and it is clear that Erdogan is more focused on growth in Turkey, and not so focused on fighting inflation,” Liam Peach, senior emerging markets economist at Capital Economics, he told CNBC.

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

Timothy Ash, an emerging markets strategist at BlueBay Asset Management, also expects a 100 basis point cut. Erdogan will not need a justification for this, Ash said, citing future elections as the reason for the move.

Analysts at investment bank MUFG, meanwhile, expect a suspension at the current rate of 13%.

Economists expect continued high inflation and a further decline in the lira, which has already fallen by 27% against the dollar since the beginning of the year and by 53% in the last year.

Erdogan, meanwhile, remains optimistic, expecting inflation to drop by the end of the year. “Inflation is not an insurmountable economic threat. I am an economist,” the president said in an interview Tuesday. Erdogan is not a trained economist.

Regarding the effect of Erdogan’s decisions on the Turkish stock market, Ash said: “The risk of these unorthodox monetary policies is that they create bad resource allocation, bubbles, which eventually burst, causing big risks to macro-financial stability.” .

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