Government bond markets, and particularly the treasury market have been concerned this year about the possibility of sharp increases in inflation. Are these concerns valid? The answer is ‘yes-and-no’. The markets should be wise to the prospects of higher inflation over the longer-term, but calm about rising prices in coming months. Concerns about inflation have risen for several reasons. As commodity prices surge and, while that has had immediate price impacts, particularly from energy, there could be second-round as well as firms’ costs rise. Secondly there are base effects from the very weak inflation in Q2 last year as the pandemic first gripped economies. There’s the possibility that pent-up demand, stoked by aggressive policy easing will overwhelm supply, cause bottlenecks and shortages, resulting in much higher prices. Finally, particularly at the Fed, there is the desire of policymakers to aim for higher inflation than before to meet an ‘average’ inflation target of 2%. Market watchers will likely find that other central banks act in a similar way even if they have not made the same formal switch as the Fed.
CONFRONTING THE CONFINDENCE CRISIS
Dollarization has resumed its climb in the intervening weeks since Naci Agbal’s dismissal from the CBRT, surging to over 52% of deposits, while Governor Kavcioglu is on the warpath to shore up investor confidence. However, without a much-needed policy anchor, the bestcase scenario for Turkey may be stagnation of dollar deposits, rather than de-dollarization. Our working assumption is that until the confidence equation is adequately addressed, the portfolio inflows that materialized under Agbal will fully reverse. This translates into another USD 5.9bn in near-term portfolio outflows. While political constraints against rate hikes will persist, rendering hikes unlikely, barring exceptional circumstances, market conditions conducive to a rate cut may not imminently appear either. We anticipate the +2.8% real policy rate to narrow substantially, but remain modestly positive. Our base case has now shifted from one in which loose monetary policy settings trigger a currency crisis into one in which a somewhat-tight policy stance remains in place, helping to stabilize bond yields and limit excessive TRY depreciation over the coming quarters.
Phoenix Kallen, strategist, Societe Generale, April 14
CBRT IN A FIX
The MPC meeting passed without incident, as the market had broadly anticipated. The lira exchange rate has remained broadly stable afterward. The CBRT left monetary policy unchanged, but there was some concern that the MPC statement had removed a sentence about readiness to deliver more rate hikes if required, and also removing the promise to keep monetary policy decisively tight for an extended period of time. We were not surprised by this. We were surprised by something else: that CBRT left intact the sentence that the policy rate would be maintained at a level higher than inflation so that a strong disinflationary effect would be produced – this would be maintained until strong indicators pointed to a permanent fall in inflation, and the medium-term 5% inflation target had been reached.
Tatha Ghose, strategist, Commerzbank, April 16