(Bloomberg) -- Turkey’s central bank governor delivered his most emphatic message yet to foreign investors worried about premature easing, saying he wants to ensure he can meet inflation goals beyond this year before discussing interest-rate cuts.
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“Any actions we take on policy rates should be calibrated so as to hit the inflation target in 2025 and beyond,” Fatih Karahan told Bloomberg in the first sitdown interview he’s given since being appointed more than five months ago.
With Turkey’s inflation slowing in June for the first time in eight months, speculation has started that Karahan could soon cut the bank’s key rate from 50% as price increases start to decelerate from above 70%.
Karahan, 42, a former economist and policy adviser at the Federal Reserve Bank of New York, is having to push back the horizon for a possible cut that some banks like Goldman Sachs Group Inc. expect already this quarter. Rates have been on pause since April since an aggressive round of hikes lifted the benchmark by over 40 percentage points in less than a year.
Speaking at the central bank’s Istanbul offices on Thursday, Karahan refrained from commenting on the potential timing of rate cuts but said “we need to maintain our cautious stance.”
Q&A: Turkish Central Banker Comments on Policy Guidance, Inflation
Thrust into the spotlight by the shock departure of his predecessor, Hafize Gaye Erkan, Karahan is presiding over an economy thrown off balance by an era of cheap money under President Recep Tayyip Erdogan that’s been blamed for a series of currency crises and a blowup of inflation above 75%.
With inflation finally on the decline and domestic demand starting to sag, the biggest obstacle that now stands in the way of easing is the vast gap in expectations of businesses and households and the central bank’s own forecasts. It projects inflation will almost halve to 38% by the end of this year, before slowing to 14% in 2025 and 9% the following year.
‘Whatever It Takes’
“Achieving this year’s target is critical for gaining credibility and we are doing whatever it takes,” Karahan said. “But it’s important to note that it’s not the final goal.”
At the heart of the challenge facing Karahan are consumer habits forged by years of living with one of the world’s fastest inflation rates. That’s left the $1.1 trillion economy trapped in a self-fulfilling cycle that causes prices to keep rising faster as expectations for higher inflation heat up demand.
Surveys from the central bank show households still see inflation above 70% a year from now. It’s an assessment sharply at odds with views in the market that end-2024 price growth will come much closer to the 42% upper range of the central bank’s forecast.
“We want to see clearer improvements in households’ and firms’ expectations so we can take some comfort that inflation expectations will support the disinflation process,” Karahan said.
Although inflation decelerated faster than forecast in June, it’s “premature” to conclude that its decline is significant enough and can be sustained, said Karahan.
In July, the governor expects electricity and administered price increases will add 1.5 percentage points to monthly inflation. That shouldn’t shift the outlook since the central bank already factored in the increase into its forecast, he said.
Karahan is due to provide the central bank’s fresh inflation projections next month at a quarterly event.
As Karahan maps out his next steps, the focus is on cooling domestic demand and continuing to narrow the deficit in the current account that’s long hobbled Turkey’s finances.
One outcome of the tight policy has been a real appreciation of the Turkish lira, according to Karahan, which he said is a “direct consequence” of high rates making Turkish assets more attractive.
Economists and companies have warned that an expensive currency could damage the competitiveness of Turkish exports and eventually result in stronger demand for foreign products.
But Karahan instead expects the restrictive monetary policy to hold back domestic demand, thereby lowering imports and narrowing the current account deficit.
Swap Limits
Still, authorities are on alert to avoid what they consider excessive gains in the lira as a result of inflows that risk flooding the financial system with liquidity. Restrictions on offshore currency swaps — originally designed to deter short sellers — have remained in place, restraining foreign money from pouring into lira-denominated assets.
An easing of access to lira abroad has been a key demand from international investors who need to hedge their exposure to the local currency. Officials worry that lifting the caps could result in greater volatility in the lira.
So far, the rules have helped make the liquidity problem more manageable, according to the governor. Turkey’s banking watchdog has the authority over the regulations, though it’s discussing their future in coordination with other officials, Karahan said.
Turkey saw more than $8 billion of bond inflows in the second quarter and that’s helped the central bank build up its reserves at a pace not seen in the last 40 years, according to Bloomberg Economics.
“We have to balance the need to improve our reserve position with our main goal of achieving disinflation, which requires avoiding excess liquidity and preventing vulnerabilities from capital flows,” Karahan said. “So far, we have managed these trade-offs well, and not easing the regulations helped.”
Going forward, he said the bank would like to reduce is foreign-exchange liabilities and review deposit agreements with international counterparties.
While reserves need to be further strengthened, the primary goal is to achieve disinflation in line with targets, said Karahan. “We will always continue to prioritize price stability and accumulate reserves as market conditions allow.”
--With assistance from Paul Wallace.
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