Turkey's Central Bank Aims to Reduce Inflation to 36% by Year-End, Boosting Investor Confidence

Key Takeaway

• Turkey's central bank targets reducing inflation to 36% by year-end, a move seen as optimistic but potentially confidence-boosting for investors.
• Economic recalibration includes nine consecutive rate hikes and discussions on easing offshore currency swap restrictions, positively impacting markets.
• Global reduction in inflation fears aligns with Turkey's monetary policy adjustments, signaling potential for increased foreign investment and market stability.

Inflation Targets and Monetary Policy

Turkey's central bank, under the leadership of Governor Fatih Karahan, is set to present its updated inflation outlook, maintaining an ambitious target of reducing inflation to 36% by year-end. This forecast remains more optimistic than most analysts' expectations, with only one Bloomberg-surveyed analyst sharing a similar view. The central bank's approach marks a shift from previous strategies, aiming to use these forecasts as policy-shaping targets and committing to "whatever it takes" to combat inflation. Altug Ozaslan, CEO of Fortuna Capital, suggests that maintaining the 36% forecast, coupled with signals of further monetary tightening, could bolster investor confidence and attract inflows into government bonds.

Economic Adjustments and Expectations

Turkey has been navigating through a period of economic recalibration, adopting more conventional economic policies. With inflation rates surpassing those of countries like Venezuela and real interest rates in negative territory, the central bank's strategies are under close scrutiny. However, officials argue that the real measure of policy tightness should consider the differential between borrowing costs and projected inflation paths, indicating a positive rate stance since last November. The upcoming inflation report is anticipated to coincide with a peak in price growth, with expectations of a subsequent decline due to statistical base effects and the impact of nine consecutive rate hikes.

Market Reactions and Future Projections

The discussions on easing offshore currency swap restrictions have sparked positive market reactions, with Turkish banking stocks rallying and credit default swaps tightening to their lowest since February 2021. This potential policy change aims to boost foreign investment and lira market liquidity by improving hedging options against lira exposure. Meanwhile, global markets are showing signs of reduced inflation fears, with stocks and bonds rising in tandem. This shift in sentiment is supported by longer positioning in US stocks and a recent uptick in net long bond positioning, despite ongoing concerns about inflation's persistence.

Street Views

• Altug Ozaslan, Fortuna Capital (Neutral on Turkish government bonds):

  "Investors’ conviction in the monetary policy and possible moves to further tighten liquidity are key to increase the appeal and draw inflows into government bonds."

• Morgan Stanley Analysts (Neutral on Turkey's inflation forecast):

  "Morgan Stanley expects the central bank’s year-end calls to stay the same as it sees them as intermediate inflation targets."

• Goldman Sachs Group Inc. Analysts (Neutral on Turkey's inflation projection adjustment):

  "Analysts at Goldman Sachs Group Inc. instead anticipate policymakers could raise the mid-point of their projection to 38% and possibly narrow the uncertainty band as we are closer to the end of the year."