Turkey’s central bank on March 20 delivered a surprise move, announcing a decision made by an emergency sitting of its rate-setting committe to suspend the regulator's one-week repo auctions and hike its overnight funding rate by 200bp to 46%.

Under normal conditions, the one-week repo rate, currently standing at 42.5%, is the main policy rate. Thus, the move suggests a 350-bp rate hike on paper.

No hike in effect

The problem is that the system is still flooded with excessive lira liquidity due to aggressive FX purchases made by the central bank since 2023.

Tweet: The central bank is dealing with the absorbption of around Turkish lira (TRY) 1 trillion ($26bn) of excessive liquidity in the system. As a result, its funding rates remain idle.

Despite the FX sales into the market across the last two days, the central bank’s policy rates remain idle. And, the emergency rate hike is actually in effect no hike at all.

Tweet: A tightening move, but it only has a signal effect due to excess liquidity.

Circulated information indicates that the authority sold around $10bn on March 19 and March 20 to stop the lira’s slide into treacherous uncharted territory amid the latest political turmoil in the country.

To deal with the excessive lira liquidity, the central bank on March 20 launched Turkish lira (TRY) 600bn worth of one-day Turkish lira depo auctions in addition to TRY 20bn worth of one-week, one-month and two-month auctions.

In total, it aimed to absorb TRY 660bn ($17bn) from the system.

The central bank conducts sterilisation transactions (to absorb the excessive lira liquidity in the system) via depo auctions and reverse swap transactions, along with reserve requirements.

In one-week repo auctions, the central bank provides TRY 5bn to the system and then absorbs TRY 800bn on average via depo auctions, @e507 noted in a tweet.

If the central bank was to sell an additional $20bn from its reserves, its policy rate would be activated (as the excessive liquidity in the market would dry up and local banks would go to the central bank’s funding windows), he added.

Tweet: API means Acik Piyasa Islemleri, or Open Market Transactions.

Smelling blood?

The ‘orthodox’ economic management at the helm in Turkey has obviously made an attempt to signal that it is ready to hike rates.

Tweet: “You were expecting a discount in April, we may not.”

However, emergency rate hikes are always risky. It could signal a bleeding into the market, inviting  sharks from around the globe to take a bite.

Tweet: "Net reserves excluding swaps" saw minus $60-70bn at their height. So, someone who does not have $100bn worth of Turkish lira to sell against USD would fall short of wounding Turkey’s central bank.

If Turks were to rush to buy dollars, it would be a game-changer. So far, they are not queuing in front of the exchange offices.

Ex-con

Moreover, Turkey’s central bank is an ex-con when it comes to irrationally abusing its legendary ‘interest rate corridor’ policy.

In the 'unorthodox' days, when Turkey’s president, Recep Tayyip Erdogan, was refusing to allow the authority to hike its policy rate, the central bank for long periods pushed local banks not just to the overnight window, but even to the late liquidity window.

(See the Turkish central bank’s policy rates here.)

So, a revival of the legendary corridor is also not an extremely 'orthodox' signal.

Rate cut expectations scrapped

On April 17, the monetary policy committee (MPC) of the central bank will hold its next scheduled meeting. If it can manage to survive till then, the "orthodox" crew will be expected to scrap this corridor hooey.

On May 20, just prior to the emergency rate hike announcement, bne IntelliNews noted: “Another 250-bp cut still remains the most likely scenario.”

“If the regime loses its grip on the USD/TRY, rate hikes could be on the cards. However, so far, this is not the case,” this publication added.

As things stand, the 250-bp rate cut scenario has been scrapped. A rate hike of at least 200bp to fix the symmetry of the interest rate corridor is on the cards.

It is very likely that the coming days may challenge the current expectations.

Derivative transactions revived

Also on March 20, the central bank relaunched Turkish lira-settled FX forward selling transactions.

The authority had zeroed the stock of such contracts in June last year thanks to the recovery in its FX reserves over carry trade inflows. At their heights, the stock saw $9-10bn in 2023.

Here we have an okay move. It is obvious that the regulator is heavily selling FX and that it could utilise a derivative tool.

Also on March 20, the overnight lira borrowing rate jumped to 136%, signalling that authorities have again ordered local banks to halt providing liquidity to the market.