Stockholm (Ekonamik) – Two central bank meetings this week brought another two monetary policy authorities to the dovish camp. The central banks of Russia (CBR) and Turkey (TCMB) both held their policy rates constant at 7.75% and 24%, respectively. Both central banks are notorious for recently hiking rates, so the decisions are significant.
“In April, annual inflation started to slow down and declined to 5.1%, according to the estimate as of 22 April,” noted the CBR’s statement. “Consumer prices current growth rates tend to be somewhat below the Bank of Russia’s forecast. The VAT increase pass-through to prices has largely materialised. The Bank of Russia’s pre-emptive key rate hikes in September and December 2018 helped return annualised monthly consumer price growth rates to levels close to 4%.” The Russian monetary authority also noted that “temporary disinflationary factors contributed to slowing consumer price growth, among those, ruble appreciation since the beginning of the year.” The forecast of the Bank of Russia is that “annual inflation will return to 4% in the first half of 2020.”
To understand the ruble appreciation comment it is necessary to remember that Russia imports 40% of its food, so monetary policy and its pass-through to inflation matters. From this point of view, the sanctions and trade restrictions applied by the EU and the USA have been argued to have a non-negligible effect on the Russian economy and inflation, in particular. This effect is patent in the depreciation of the ruble following the Crimean crisis of 2014 and the steep increase in consumer price inflation that accompanied it, which was only stabilised at the expense of rises in policy rates by the CBR.
Source: Bank for International Settlements (BIS)
Perhaps unusually, this means that the conclusion of the Muller investigation that there was no collusion between the Trump 2016 presidential campaign and Russia is significant. According to UBS’s April Emerging Markets Fixed Income report, it “reduces the urgency for the US Congress to impose additional sanctions on Russia.” The next rate review meeting will be on June 14.
Across the Black Sea, the TCMB justified its decision with reference to import prices and high inflation. “Developments in domestic demand conditions have led to some improvement in inflation indicators,” said the TCMB in its monetary policy decision. “Yet, higher food and import prices and the elevated course of inflation expectations point to continued risks to price stability. Accordingly, the Committee has decided to maintain the tight monetary policy stance until inflation outlook displays a significant improvement.”
As the figure below shows, the Turkish central bank waited almost two years to start reacting to the acceleration of Turkish consumer price inflation (red line). It was only when it exploded in 2018, causing the Turkish lira (yellow line) to lose 30% of its value that the central bank reacted. This process inevitably led to an explosion of debt servicing costs of the private non-financial sector (black line), reinforce by the increase in foreign borrowing that took place in Turkey over the last decade.
According to UBS’s April Emerging Markets Fixed Income report, “Turkey remains the key market to watch. Following the collapse of the Turkish Lira last August, the government allowed higher interest rates and seems willing to tolerate lower growth. However, fiscal spending has increased ahead of the local elections at the end of March. Performance of Turkish bonds hinges on the government’s ability to switch to prudent policies in the aftermath of the elections and avoid tensions with the US.”
“Turkey’s asset prices were also impacted by the local elections on 30 March,” adds the same report. “Markets grew increasingly nervous about the potential election outcomes, while locals dollarized their portfolios further. As a result, the currency came under severe pressure ahead of the elections, forcing the central bank to take counter measures that lifted interbank rates as high as 1,200%.” As Ekonamik expected, the ruling AKP lost the Ankara and Istanbul municipalities. The implications of this result are difficult to disentangle. “Given the weaker AKP position we could see a switch to a more market-friendly environment where authorities start implementing some of the highly needed short-term and structural policy reforms. If this happens then Turkey might avoid tumbling into the abyss of greater economic crisis,” concludes Nikolay Markov, Senior Economist at Pictet Asset Management.