Turkey: Central Bank continues to test its new policy mix
January 20, 2011
At its 20 January meeting, the Monetary Policy Committee (MPC) cut the 1-week repo rate by 25 basis points to 6.25%. The move is aimed at curbing the excess of short-term capital inflows and marked the second consecutive interest rate cut since December last year. Lower interest rates are likely to reduce the attractiveness of Turkish fixed income assets, hence contributing to the weakening of the Turkish lira. The second leg of the new policy mix is focused on cooling credit expansion by raising banks' reserve requirements ratios (RRR). On 24 January, the Central Bank (CBRT) announced a RRR hike on demand deposits, raising the rate from 8% to 12%. With this move, the Bank expects credit supply to shrink and place a drag on consumer spending, which will help to redress the imbalance between domestic and external demand growth pace. According to the press release, the main goal of the CBRT is to achieve and maintain financial and price stability. That said, ?the divergence between domestic and foreign demand growth (fanned by the recent surge in short-term capital inflows) coupled with rapid credit expansion is increasing the current account deficit, hence contributing to risks regarding financial stability?. In this context, the Bank decided to implement a new policy based on ?the use of multiple instruments to manage both internal and external balances?. The MPC stated that ?a policy mix of a lower policy rate coupled with higher reserve requirements emerges as an optimal policy mix under the current conditions? and that ?the net impact of these measures taken ? and to be taken in the future ? will be restrictive?. The MPC will meet again on 15 February and market analysts don't expect further rate cuts.