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Goldman Says Erdogan to Get His Wish on Rates, Warns on Lira

Paul Abelsky
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Goldman Says Erdogan to Get His Wish on Rates, Warns on Lira

(Bloomberg) -- Turkey’s central bank will bring interest rates to single digits within months, as demanded by President Recep Tayyip Erdogan, before they start to rise again next year as price pressures bubble up, according to Goldman Sachs Group Inc.

“The authorities will prioritize growth and reduce the policy rate as much as possible without destabilizing the lira,” Goldman Sachs economists Murat Unur and Clemens Grafe said in a report. “Recent inflation dynamics and growth in money aggregates, in our view, also increase the risk of renewed lira volatility.”

The central bank isn’t done yet, even after shocking much of the market with an easing cycle that’s more than halved Turkey’s benchmark since last July to 11.25%. Erdogan has been promising to deliver rates in single digits this year and believes inflation will follow suit -- a reflection of his unorthodox view that lower borrowing costs are more effective at slowing prices. Most economists and central banks around the world believe the opposite to be true.

Goldman now expects the key rate to reach 10.75% at the end of 1Q, 10% at the end of 2Q, 9.75% at the end of 3Q, and then stay on hold until end-2020Previous forecasts were for the benchmark at 11.5% by the end of 1Q, 11% by the end of 2Q, and then remaining unchanged through the rest of the yearMost economists surveyed by Bloomberg in January predicted Turkey’s rate will end this year at 9.5% and then reach 9% in the second quarter of 2021

“We were wrong in particular about how rapidly Turkey’s central bank could cut rates without undermining money demand or leading to renewed lira volatility,” Unur and Grafe said.

But with Turkish rates turning negative when adjusted for realized inflation, the lira is coming under more strain. On Friday, it weakened past the 6-per-dollar mark for the first time since late May, breaking through a key level that state banks have been defending.

Steadying the Lira

To stabilize the market, Turkey’s banking regulator announced on Sunday that it will limit the amount of hard currency local lenders can exchange for lira with foreign investors by cutting the limit on foreign-exchange swaps and derivatives deals. The Turkish currency strengthened in Asian trading.

Although Goldman economists are maintaining their end-2020 forecast for price growth at 9%, they warned that a “build-up of inflationary risks” may get in the way of monetary easing.

An uptick in the core index, which strips out the impact of volatile items such as food and energy, and services inflation above 12% might mean that price growth will end up “settling in the low teens, rather than high single digits.”

The central bank last month kept its projections for inflation at 8.2% for 2020 and 5.4% by the end of 2021. On an annual basis, it accelerated faster than forecast for a second month, reaching 12.2% in January.

“Inflationary developments will eventually limit the extent to which Turkey’s central bank can reduce rates, and we continue to expect rates to rise in the medium term as global financial conditions tighten,” Unur and Grafe said.

(Updates with banking regulator’s announcement under ‘Steadying the Lira’ subheadline)

--With assistance from Barbara Sladkowska.

To contact the reporter on this story: Paul Abelsky in Dubai at pabelsky@bloomberg.net

To contact the editors responsible for this story: Lin Noueihed at lnoueihed@bloomberg.net, Paul Abelsky, Michael Gunn

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