Turkish Central Bank Surprises with Another Rate Decision

The Turkish Central Bank finally gets the idea that if central banks around the world are busy aggressively cutting rates, you should probably be doing something as well.

So the TCB announced another shock decision to cut rates by 125 basis points. That lowers the rate of borrowing from 16.25% to 15%, and the rate of lending from 18.75% to 17.50%.

Currency markets for the last few days have almost discounted expectations that dollars will soon get thrown out of helicopters and fall on the ground in perpetual rain. At least that’s how I make sense of the sharp dollar move.

Now I want to ask the market participant: How does the Turkish currency borrowing rate of 15% and lending rate of 17.50% look in a world where rates of two of the three largest economies now stand at almost zero percent?

Assume for a moment that you are the central bank of country XYZ. If you are not cutting rates in line with the rest of the world, you may as well consider yourself as “raising” rates even if you are not touching rates at all.

Let’s move to physics for further demonstration. All that matters about motion is your movement relative to a specified frame of reference. You may believe you are not moving at all, but if your frame of reference is moving with respect to you, then you are also moving with respect to your frame of reference. Especially if that “frame of reference” happens to be the Federal Reserve leading the world’s largest economy: When the Fed announces a rate cut of 75 basis points and indicates further quantitative easing if need be, you may interpret that as a relative rate hike on the part of another economy whose central bank remains less aggressive…

Swiss National Bank is already at 0.50%. Bank of Canada is at 1.50%. Financial Times reports that the Bank of England’s released minutes raised speculation of aggressive rate cuts in January, which may explain the recent sterling weakness. Japan just cut its key rate to 0.1 percent, which could very well be a panic response to the yen overvaluation problem, among other things. I say this because governor Shirakawa has often affirmed that bringing rates closer to zero would not encourage the bank lending activity, but then here comes this move in the aftermath of the “helicoptering” Fed.

Central banks, specifically the smaller ones, find themselves to be reacting to Fed decisions as well. That’s not such a nice position to be in, so they can always go back to the central bank minutes and minutiae as supporting documents that explain the economic rationale behind their rate decisions.

However, given a world order in which central banks, specifically the Fed, seem to vow liquidity at all costs, your shallow (or not so shallow) pool will get clobbered by someone else’s money if you don’t act accordingly. This will have some serious consequences, one of which is a currency move that will further damage exports which have already been hurt in a down global economy.

Associated Press has this note by Tomoko Hosaka who elaborates on the issue:

The Japanese currency's dramatic surge this week has triggered strong language on the political front, with government officials dropping hints at possible intervention to limit the yen's climb and protect Japanese exporters.

Of course throwing cash at the problem won’t solve it, but that’s the kind of toolkit that central banks have in an attempt to deal with the current situation. And when the big guy comes up with that kind of move, there’s not much that others can do but to follow the rules of the game being played.

I must add that in its press release on interest rates, the Turkish Central Bank has credited the falling inflationary pressures due to the slowdown as the main factor for its decision to cut interest rates. Of course it sounds much better than “We did it because the Fed did so”.

Recent readings indicate that the slowdown in the domestic economic activity has intensified. Ongoing problems in international credit markets and the global economy are expected to continue to restrain both the domestic and external demand for an extended period, putting downward pressure on inflation. Moreover, the developments in oil and other commodity prices are having a favorable impact on disinflation. Looking ahead, the Committee has judged that inflation will display a rapid fall in the forthcoming period. Accordingly, the Committee has decided to lower short-term interest rates by 125 basis points.

Uncertainties regarding the impact of the problems in financial markets on the real economy remain at high levels. The Central Bank will continue to take the necessary measures to contain the adverse effects of the global financial turmoil on the domestic economy, provided that they do not conflict with the price stability objective.

The extent and the timing of the next rate cut will depend on the factors affecting inflation outlook.

Comments

[jepittman:]

The issues facing the Turkish Central Bank are the same issues facing every central bank on the planet: how to combat a global recession and the resulting deflationary consequences. The drop in rates by the Turkish Central Bank is PRECISLY the correct policy action to combat this. The rate cuts by the central banks in the developed economies provides the cover for rate cuts in emerging economies. This is all part of the solution to the syncronized global recession: syncronized economic stimulus via coordinated monetary policy.

2008 Dec 21 07:50 PM