Turkey delivers massive rate hike to defend lira

CNBC.com | Tuesday, 28 Jan 2014 | 5:01 PM ET

The Turkish central bank raised its overnight lending rate to 12 percent from 7.75 percent and the overnight borrowing rate to 8 percent from 3.5 percent late Tuesday, in a surprisingly strong move to defend the country's embattled currency.

The lira immediately strengthened to 2.2 to the dollar from 2.253 after the decision. The rate hike was much sharper than expected eight economists polled by the Wall Street Journal had expected an increase of three percentage points at the most.

Dow futures spiked 150 points on the closely watched move, while Asia equity markets were expected to open higher with the strong action by Turkey seen lifting investor sentiment.

" It's great news and establishes that the Turkish central bank is independent," Ed Ponsi, managing director at Barchetta Capital Management, told CNBC Asia's " Squawk Box."


(Read more: Turkey: What's going on and why you should care)

" I think the move does help Turkey but it doesn't make everyone feel better across emerging markets such as Argentina, which is in a very different position," he added.


Emerging markets have come under renewed pressure in the past week, hurt by concerns about China's economy and the impact of a tapering of the U.S. Federal Reserve's monetary stimulus - especially on those countries with a high debt burden.

(Read more: Will the Fed throw emerging markets a bone?)


Local investors have been selling the lira in favor of foreign currencies, and international investors have been staying away from the Turkish currency, pushing its value down to record lows earlier this week.

The cost of Turkey's debt is also rising alarmingly quickly, with 10-year debt hitting 10.45 percent, its highest since 2010.


Turkey is not the only emerging market to suffer in recent weeks, with Argentina and Ukraine both punished for political turmoil and large current account deficits.

(Read more: Emerging market currencies: A well-thought-out crisis)


Yet it is a substantially bigger economy than either of these, and World Bank projections suggest it should rise from the 17th biggest economy in the world in 2012 to the 14th in 2050. Its borders with Europe, Syria and Iran are another reason it is strategically important that a stable government and economy are in place.


The activity in Turkey came as Federal Reserve officials gathered in Washington, where they are expected to cut another $10 billion from the Fed's monthly bond buying program Wednesday.

The Fed started tapering the original $85 billion program at its December meeting. The Fed's tapering program has been seen as a drag on emerging markets, following years of extra funds flowing around global markets.

(Read more: Fed taper will remain slow and steady: CNBC survey)

Analysts said the decision by Turkey's central bank was significant since it had come across as reluctant to take action.

" It's only fitting that Turkey's central bank, which has stubbornly refused to mount a proper interest rate defense of the lira, decided to hike rates in an extremely aggressive manner in the dark of night," said Nicholas Spiro, managing director at Spiro Sovereign Strategy in a note.

" The decision to raise all three main policy rates by between 425 and 550 basis points is the most significant shift in monetary policy in a vulnerable emerging market since the U.S. Federal Reserve let the " tapering" genie out of the bottle last May," he added.

Central banks in some emerging markets have started to take action to defend their markets. India, hit hard last year when Fed tapering fears first surfaced, on Tuesday delivered a surprise interest rate hike to fight inflation.

?Reporting by Catherine Boyle and Dhara Ranasinghe

© 2014 CNBC.com

URL: http://www.cnbc.com/101359309