Struggles of the Central Bank: Turkey and Brazil



The Turkish central bank kept rates unchanged today at 7.50%, as expected. However, President Erdogan has been once again talking about monetary policy after being surprisingly quiet during the election period. Deputy Prime Minister Kurtulmus has also been very critical. So it seems like not much has changed in this regard. Inflation is still very high, the lira near historical low levels, but the government still wants rates to fall quicker.

Another source of tension for the central bank was uncertainty over the new cabinet, but it has just been announced. One of the key market-friendly names, Ali Babacan, was left out, and many of the appointments seem to be Erdogan loyalists. This probably means a pro-growth platform with a focus on spending in infrastructure and development rather than structural reforms. And it could also mean more pressure on the central bank. On the positive side, reposts suggest that Deputy Prime Minister Mahmet Simsek, a former finance minister, will have the role of economic coordinator – which is positive. So all in all it seems like a mixed bag and it is unclear how the relationship between the central bank and the government will evolve from here.

Brazil suffers from a similar uncertainly over de facto central bank independence, but it is also one of the few countries where investors don’t even agree whether the next move will be tightening or easing. The Brazilian central bank meets tomorrow and is expected to keep rates steady at 14.25%, a nine year high. But there is a lot of uncertainty going forward. According to a recent poll by Reuters, forecasts for Brazil’s interest rates at the end of 2016 ranged from 11.50% to 16.00%. The median forecast stood at 13.25%. Looking at this week’s official central bank survey (FOCUS), economists increased their SELIC forecast for end-2016 by 50 bp from last week to 13.75%. And this compares with forecasts of 12.75% back in the week of October 16. Also, the average inflation (IPCA) forecast for the next 12-month period is now just over 7.00%, meaning that the central bank’s 4.5 +/- 2% inflation target is looking evermore elusive.

Until very recently, several observers assumed that – bar another sharp bout of currency weakness – this could be the end of the hiking cycle. We have argued that the recent spike in local yields was driven by heightened risk premium, along with the move higher in US Treasuries, thus not reflecting a genuine belief that there would be more tightening in the pipeline. Rates have converged from then, as we had expected. But now the discussion about further hikes or less easing next year is gaining traction. So it seems as if both things happened: rates have fallen from their spike, but at the same time more tightening/less easing is expected. In other words, some of the risk premium consolidated itself into forecast, while some of it went away. Below is a graph of local yield curve.