By Jonathan Spicer and Nevzat Devranoglu

ISTANBUL (Reuters) – Turkey’s central bank has begun setting the stage for an interest rate cut long sought by President Tayyip Erdogan, although most analysts don’t think it will pull the trigger this week after inflation jumped and the lira took a slide.

Since March when Erdogan appointed Sahap Kavcioglu its new governor, the bank’s benchmark rate has remained at 19%. That makes it one of the highest policy rates in the world – although so too is Turkey’s inflation rate https://refini.tv/3laX5UN, which touched 19.25% last month.

Ahead of a monetary policy meeting set for 2 p.m. (1100 GMT) on Thursday in Ankara, here are four key questions:

IS A RATE CUT COMING?

The central bank changed its tune over the past few weeks after months of hawkish talk, which allowed the lira’s recovery from a record low in June.

Kavcioglu made no mention of his pledge not to raise the policy rate above inflation during the conference calls on September 1. Two days later, data showed inflation did indeed surpass 19% https://tmsnrt.rs/3yTLHBq, leaving real rates negative.

Kavcioglu started to minimize the “headline” figure of inflation and stressed instead that the “core”, which is less, is better suited given the consequences from the pandemic.

On Sept. 8, Kavcioglu stated in a speech that an almost 30% increase in food prices is indicative of “short term volatilities”. Therefore, the bank will be focusing more on the core figure which fell to 16.76%. He said that the policy was not too restrictive and forecasted a fall in prices during the fourth quarter.

This has led investors to interpret it as adovish sign that rates cuts could be coming. Others have warned that they could make a mistake by introducing too much easing.

Reuters polled seventeen economists who expected easing to start in the fourth-quarter. Only two of those, the Institute of International Finance and fourteen others, predicted it would begin this week.

Ozlem Derici Sengul from Spinn Consulting in Istanbul, stated that although most economists expect no rate reduction, their new guidance indicates it is not surprising to see one starting on Sept. 23, if there is a slight decrease in core inflation.

Graphic: Central bank shifts focus to core inflation https://graphics.reuters.com/TURKEY-CENBANK/GOVERNOR/lbvgnnkmbpq/chart.png

HOW LONG WILL ERDOGAN WAIT?

An array of analysts believe Erdogan may be becoming impatient for monetary stimulation, as loans are very expensive and the country faces difficult elections in 2023. Some analysts believe a quick rate cut might signal plans to hold an early election.

Due to inflation pressures caused by increased global commodity prices, a rise in summer demand and the ease of pandemic restrictions, the central banks has advised patience.

Despite the risk of currency depreciation https://tmsnrt.rs/3neUCLN and stubbornly high inflation, Erdogan will likely get what he wants soon.

He is a self-described enemy of interest rates and he oust the previous three chiefs of central banks within 20-months due to policy differences.

Erdogan stated that he had spoken to Kavcioglu in June about the necessity of a rate reduction after August.

He stated that rates would start falling in August because it is “impossible” for inflation to increase.

Phoenix Kalen (OTC), global head for emerging markets research, Societe Generale, stated that market tensions will increase because President Erdogan is continuing to put pressure on rate cuts while inflation pressures are increasing.

Graphic: Erdogan speaks, currency retreats https://graphics.reuters.com/TURKEY-CURRENCY/LIRA/zjvqkkxdevx/chart.png

WHEN WILL INFLATION COOL DOWN?

The base effect of the jump in late 2013 that caused inflation to continue rising, which should keep annual headline inflation high through October, and then begin to fall in November.

The government forecasts inflation will drop to 16.2% by the end of the year, while Goldman Sachs (NYSE:) and Deutsche Bank (DE:) see 16.7%. Analysts believe this will allow at least one rate decrease in the fourth-quarter.

However, Turkey is a major importer of lira. This could make inflation rise and even hinder any rate cuts. The 45.5% increase in producer price index’s annual rise last month reflects high import costs.

There is also the possibility that the U.S. Federal Reserve will remove its Pandemic-era stimulative sooner than planned. This would increase U.S. yields, and harm currencies from emerging markets with high debts, such as Turkey.

Analysts believe the greatest problem with the central bank is its diminished credibility when it comes to political interference. The result has been years of double-digit increases in prices and little assurance that inflation will return to the target of 5%.

Ricardo Reis, a London School of Economics professor who presented a paper this month https://www.brookings.edu/wp-content/uploads/2021/09/Losing-the-Inflation-Anchor_Conf-Draft.pdf at the Brookings Institute, found that Turkey’s “inflation anchor seems definitely lost” based on market expectations data from 2018 to 2021.

Graphic: Turkey’s inflation stands apart from peers https://fingfx.thomsonreuters.com/gfx/mkt/byprjloxnpe/EMinflation.PNG

HOW ARE INVESTORS AND SAVERS PREPARING?

Inflation pressure was downplayed by Kavcioglu earlier this month and the lira dropped 1.5%, its highest daily decline since May. Since Erdogan took over from Naci Agbal, Kavcioglu’s conservative predecessor in March, the lira has fallen nearly 15%.

After years of decreasing their Turkish debt, only 5% is held by foreign investors.

Some believe that the attractiveness of lira assets is due to rebounds in tourism revenue, exports and central bank foreign reserves.

Kieran Curtis, portfolio manager at Aberdeen Standard Investments said that exports will continue to grow despite Europe’s low inventories.

It does seem to me that there’s more flexibility from authorities, but he stated that no one is anticipating a decrease in the meeting.

In Turkey, soaring prices for basic goods such as food and furnishings have prompted individuals and companies to snap up record levels of dollars and gold https://tmsnrt.rs/3jWu3sL. The country held $238 trillion in hard currency this month.

Graphic: Turks flock to hard currencies https://graphics.reuters.com/TURKEY-CENBANK/FOREX/lgvdwwrqrpo/chart.png