Jonathan Spicer and Tommy Wilkes

LONDON/ISTANBUL, (Reuters) – Turkey’s central bank will announce more rate cuts Thursday – a move President Tayyip Erdogan is likely to cheer. However analysts fear that it could raise inflation and speed up the decline of the lira.

The currency has suffered a steep selloff in the run up to the bank’s policy decision expected at 2 p.m. (1100 GMT) on Thursday, slumping more than 6% in November and crashing through the 10 to the dollar watershed to a new record low https://www.reuters.com/world/middle-east/turkish-lira-hits-new-depths-ahead-another-expected-rate-cut-2021-11-16/#:~:text=ANKARA%2C%20Nov%2016%20(Reuters),pressure%20and%20slashing%20interest%20rates.

These are the four main questions that face the central bank after it slashed its policy rates by 300 basis point since September.

1. WHAT WILL THE CENTRAL BOARD DO?

Turkey is expected to reduce its policy rate by 100 basis points https://www.reuters.com/world/middle-east/turkish-cenbank-cut-policy-rate-15-lira-hits-record-lows-2021-11-11 to 15%, according to a Reuters poll.

Although inflation has reached 2-1/2 year highs in October, analysts believe that October’s reading was lower than expected. But, they cautioned that banks may be held responsible for its recent slide.

GRAPHIC: Turkey rates and inflation https://fingfx.thomsonreuters.com/gfx/mkt/egpbkaqelvq/turkey%20rates.PNG

Erdogan is a radical believer that lower rates will reduce inflation. The last three chiefs of central banks were ousted by Erdogan over a period of 20 months because they had policy differences.

The March appointment of Governor Sahap Kavioglu ended months hawkish talk by September, when he set the foundation for further easing. Last month, the central bank admitted that there wasn’t enough room to ease monetary policy by year end.

Recent cuts, however, have shaken any investor faith in the bank’s independence.

Erdogan, a self-described enemy of interest rates, has his eyes firmly on elections to be held no later https://www.reuters.com/world/middle-east/turkey-cut-some-fixed-electricity-fees-help-consumers-2021-11-08 than mid-2023. The pragmatic president might reconsider his call for monetary stimuli, or refuse to bow down in the face of falling popularity.

2. HOW LONG CANNOT TURKEY PLAY THE GAME?

Analysts warn that cutting rates in the face of double-digit inflation or a falling currency can be dangerous.

Erik Meyersson (a Handelsbankenan senior economist based in Sweden who is an expert in Turkey) said, “Unless we see significant policy reverses in Turkey anytime soon, the country appears set to enter its third currency crisis ever since 2018”.

Turkey has far less ammunition to defend the currency than in previous years with foreign exchange reserves https://www.reuters.com/world/middle-east/turkey-raises-required-reserves-forex-liabilities-official-gazette-2021-11-08 falling. The Q2 central bank reserve coverage was less than 3 months of imports. This is down from the 4.5 that it had in 2019.

GRAPHIC: Turkey reserves cover https://fingfx.thomsonreuters.com/gfx/mkt/gkplgdakyvb/turkey%20reserves.PNG

Turkey might not be able cut as much, particularly with global central banks, such the U.S. Federal Reserve, planning to tighten their policy to reduce inflation.

Goldman Sachs (NYSE) analysts stated, “Going ahead, we don’t believe that the current policy mixture is sustainable, and rates will eventually have to go higher,” Goldman Sachs forecasted. Rates would fall to 15% at year’s end, with 300 basis points of increases in the second half 2022.

A second risk is Turkey’s large-scale repayment of dollar-denominated, short-term debt.

GRAPHIC: Turkey’s external debt https://fingfx.thomsonreuters.com/gfx/mkt/zdpxonkebvx/turkey%20external%20debt.PNG

3/WHERE IS INFLATION FOUND?

Annual inflation https://www.reuters.com/business/cop/turkish-inflation-climbs-near-20-highest-2-12-years-2021-11-03 rose to 19.89% in October – four times the central bank’s target, although it argues price pressures are temporary. Recently, policymakers shifted attention to core inflation at 16.83%.

The weak lira has been pushed to the forefront by global pressures caused by soaring demand after the pandemic, disruptions in supply chains and an increase in energy prices.

Inflation rose 46.31% in October, according to producer prices. Deutsche Bank (DE:) The headline inflation forecasts that it will remain above 20% for the first half next year, and at 16% by 2022.

GRAPHIC: Forex held by Turkish local individuals and institutions https://fingfx.thomsonreuters.com/gfx/mkt/akvezmxlapr/forex%20held%20turkish.PNG

4. WHAT IS THE ERDOGAN’S ENDGAME?

Turkey’s ailing economy has been hit hard by rampant inflation and the tumble of the lira, which have eroded earnings. Erdogan’s conservative AK Party, who has ruled over Turkey for 19 year on a track record for delivering strong economic performance and high household wealth has become uneasy.

Erdogan is betting that rate cuts will stimulate the economy, supporting exports, lending and job creation. Because of the high level of foreign debts, economists believe that weakening currencies will have little impact on exports.

GRAPHIC: Lira timeline https://fingfx.thomsonreuters.com/gfx/mkt/zdvxonkjmpx/lira%20timeline.PNG