Central bank round up: Why Turkey could steal the limelight

This Thursday 13th September, three central banks will announce their latest decisions, the Bank of England at 1200BST, The Turkish central bank also at 1200 BST and the ECB at 1245 BST. Out of the three, the most exciting will be Turkey’s central bank meeting. Below we take a closer look at all three and let you know our take on what this could mean for financial markets.

Turkey: 1200 BST

The Turkish central bank is expected to tighten the one-week repo rate (a key interest rate in Turkey) to 21% from 17.5% currently. Interest rates in the country rose sharply in April and May, however, over the summer months’ interest rates remained on hold as the country battled a political crisis, saw key members of the CBRT leave office, stock prices tumble and the Turkish lira slide to a record low vs. the USD.

The expected rise in interest rates comes as things have started to calm down in the country, the lira has stabilised, although it remains weak vs. other major currencies, and the Borsa Istanbul has picked up from its lows. However the economic backdrop is showing signs of stress. GDP is falling sharply, Q2 fell to 5.2% from 7.4%, and Q3 could see an even lower figure, inflation is projected to be over 14% in the coming 12 months as a direct result of the weak lira, foreigners are pulling money out of the country and manufacturing is already in recession. So why is a rate rise a good idea?

At this stage, higher interest rates seem like the lesser of two evils. While higher rates will push up borrowing costs for individuals and businesses, it is hoped that this rate rise will also underpin the Turkish lira’s recovery, which could reduce pressure on inflation and the cost of servicing foreign currency debts. Both of these effects could help the economy in the coming months.

A rate rise would also be symbolic for the global financial community. One reason why the lira fell so sharply over the summer was partly due to fears about the political atmosphere and President Erdogan taking control of the central bank for his own economic benefit. He spoke out vociferously against rate hikes, saying that higher interest rates did not dampen inflation, which goes against traditional economic theory. He also placed his son-in-law in the finance ministry, both things spooked investors’ and triggered the Turkish financial market crisis. If the CBRT can revert back to traditional economic methods for deciding policy, without Presidential interference, then global investors may regain confidence in the economic management of the country and return to its financial markets.

There is a lot resting on this rate hike. Expectations of a hike have already boosted the lira, if the CBRT delivers on this rate hike, and signals that more hikes are due in the future, then the TRY could continue with its recovery, with 6.00 being a major level of support in USD/TRY. However, we think that the CBRT will take a more cautious path and say that rates may only rise gradually, due to the threat of recession facing the Turkish economy in the coming months. If this is the case then the upside for the lira could be limited. If the CBRT does not deliver on the expected hike then expect a bloodbath for the lira.

Bank of England: 1200 BST

No change is expected at this meeting after last month’s rate hike from the BOE. We also know that Mark Carney will stay on as Governor until January 2020. This does not mean that this meeting will be a damp squib. After a few weeks of decent economic data including stronger than expected GDP and wage data earlier this week, the BOE’s decision to hike rates last month seems to be justified.

This month’s meeting will be all about signals for future rate hikes. There seems to be a bias for hiking rates at the BOE, and this month’s statement could signal to the financial market that UK rate expectations are too low. If this is the case then there could be further upside for GBP/USD, which has been hovering around the $1.30 mark this week.

The risk for the BOE hawks is domestic politics. With party conferences coming up and the Brexit deadline getting closer, if the BOE continues to espouse increased downside risk for the UK economy from Brexit then it may trigger cracks in the fragile GBP rally. However, if the BOE stays neutral in the Brexit debate, and instead focuses on rising inflation fears then the market could rush to price in another rate hike as soon as February, which would be perceived as hawkish, and may push GBP/USD back above the 1.3087 high from Tuesday. It is worth noting that investors remain edgy about Brexit headlines and UK politics, so any negative political headlines could override the BOE and weigh on the pound as we move to the end of the week.

European Central Bank: 1245 BST

The big news from the ECB meeting might have already been announced with the leaking of news that the ECB will most likely downgrade its growth forecast due to external factors such as trade with the UK and Turkey. As we mentioned earlier, this could be good news for the UK in Brexit negotiations, as it may spur the EU side to cave in to some UK demands in order to get a trade deal before next year’s Brexit deadline. However, for this meeting a downgraded growth outlook vs. the ECB’s plan to remove monetary stimulus could make for an interesting statement. Will the ECB scale back its plans to withdraw stimulus? Or are plans already too far gone? How will the ECB reinvest the proceeds from the maturing bonds that it holds on its balance sheet in the light of lower growth?

All of this points to a weaker euro, in our view, and we think EUR/GBP may continue to decline especially if the BOE is slightly hawkish earlier in the day. Italy’s budget concerns, and the potential that Rome could flaunt the EU’s fiscal rules, may also feature in the Draghi Q&A. Any signs that the ECB is concerned about Italy, and may choose to support the country if Italian bonds come under attack, could trigger a larger sell off in the euro, although we expect Draghi and co. to choose what they say about Italy very carefully.