A failure by the Turkish central bank to hike policy rates at its July 24 Monetary Policy Committee (MPC) would trigger another Turkish lira (TRY) sell-off and probably push the regulator into an emergency rate hike anyway, Capital Economics said on July 20 in a research note.

Its warning came on the same day that Chatham House’s Turkey Project manager said in an article published in Time that Turkey is “heading for economic meltdown”.

The TRY has been subject to heavy sell-offs since the beginning of 2018, losing more than a fifth of its value against the dollar. Its latest descent was driven by the market reaction to the July 9 cabinet reshuffle in which re-elected Turkish President Recep Tayyip Erdogan made his son-in-law Berat Albayrak finance minister. Since then, the markets have fluctuated.

Capital Economics anticipates that the MPC will oblige and raise interest rates. It forecasts a 100bp hike.

A Reuters poll of economists showed on July 20 that the MPC was expected to hike the policy rate by 100-150bp on July 24. Six out of a total of 16 economists expected 100bp, another six 125bp, two 150bp and one 75bp. Only one economist expected no rate hike.

Another poll of financial institutions published by BloombergHT on July 20 showed that markets expected a 100bp rate hike. Two of 16 institutions expected 150bp, five 125bp, another five 100bp and three 75bp. Only one institution did not foresee a hike at the MPC meeting in four days' time.

J.P. Morgan said on July 20 that the markets had already priced in a 75bp rate hike and that the central bank could surprise the markets on the upside, as it has with its three latest rate decisions, by raising the policy rate by as much as 125bp.

Participants in the central bank’s latest survey of economists published on July 18 also expected the MPC to hike the key policy rate. On average, they forecast that it would move up to 18.39% from the current 17.75%.

The central bank’s main policy rate has been hiked by a cumulative 500bp since April 26, but the policymakers have nevertheless failed to make much headway in reversing the plunge of the lira. Meanwhile, fresh calls from Erdogan for lower interest rates have caused the lira to give up its post-election gains. The currency is down by almost 5% since the start of July.

“In short, market pressure for higher interest rates has built,” Liam Carson of Capital Economics said.

The TRY was trading at 4.7957, down 0.21% d/d, as of 19:30 local time on July 20 while the Istanbul stock exchange benchmark BIST-100 was up 1.16% to 94,082 at the close on the day.

Turkey’s annual consumer price inflation jumped from 12.15% in May to 15.39% in June, taking the rate up to the highest level recorded since 2003, the Turkish Statistical Institute (TUIK) announced on July 3.

Capital Economics thinks inflation has a bit further to rise. It forecasts that inflation will quicken to 13.5% at end-2018 from 11.1% in at end-2017.

Expectations for Turkey's end-2018 inflation rate rose from 12.28% in June to 13.88% in July, the central bank’s regular survey of businesses and analysts showed on July 18.

The government’s decision to lift the state of emergency as of July 18 was a symbolic move, with Erdogan seemingly taking further steps to tighten his grip on power, Carson also said.

“Lifting the state of emergency suggests that Turkey is returning to some form of normality after two years of upheaval. However, a bill proposed by the ruling AK Party that enshrines most of the emergency powers into law adds to the evidence that President Erdogan is tightening his grip on power. And, as we’ve highlighted before, he has already started to cement his control over fiscal and monetary policy,” Carson added.

Turkey’s calendar-adjusted industrial production index gained 6.4% y/y in May, very slightly higher than the 6.3% y/y growth registered in April, data from national statistics office TUIK showed on July 17.

The stronger-than-expected industrial production figure for May does, at first sight, suggest that the economy has weathered the recent financial market turmoil. But Capital Economics doubts that this resilience will last. The manufacturing PMI and a raft of other low profile data point to a sharp slowdown in the months ahead. The macroeconomic research company expects a quarter or two of negative growth and its GDP growth forecasts for Turkey lie well below the consensus at 3.5% for 2018.