The CBRT managed to surprise the markets yet again and cut its policy by 200bp to 16.00%. Market expectations were quite diverse, ranging from no change to 100bp cut. Our call was a 100bp cut. This followed the unexpected 100bp cut delivered last month. It is interesting to see significant monetary easing in an environment where price pressures are high, annual inflation is on the rise, domestic demand is robust and policy credibility is ailing. It is also interesting to see the CBRT venturing steeper rate cuts when most other central banks in the world, in either EM or DM, are either delivering or preparing to deliver tighter policies. We fear that the decision could strengthen demand-led price pressures, cause fresh cost-led pressures through a weaker lira and create stronger inflation inertia through higher inflation expectations.
Furthermore, such front-loaded easing suggests that bringing down inflation in a rapid way is not a policy priority. As a result, we have made significant upside revisions to our inflation forecasts. We have revised up the end-2021 forecast to 19.9% from 16.7% and revised up the end-2022 forecast more sharply to 16.4% from 14.5%. The revision also incorporates the recent rise in energy prices. Depending on how fast the easing cycle will be, there could be upside risks to these forecasts.
The surprises in the last two MPC decisions have clearly shown the difficulty of making forecasts based on fundamentals or based on policy guidance provided by the CBRT. To repeat, inflationary pressures remain strong and this is at least partly due to robust domestic demand. Furthermore, as evidenced by the continued (and accelerating) worsening in inflation expectations, there is a growing problem with policy credibility. In this environment, the real interest provided by the CBRT is shrinking fast. In fact, ex-post inflation is already in the red and even ex-ante real interest will likely fall below 0% within a couple of months.
Despite stubbornly high inflation, the only policy guidance sentence of the interest rate announcement note suggests that further cuts could be in the cards. The CBRT states that “till the end of the year, supply-side transitory factors leave limited room for the downward adjustment to the policy rate.” Furthermore, the CBRT puts the blame of the recent rise in inflation on transitory supply-side factors (especially in food and energy) and notes that the decelerating impact of the monetary tightening on credit and domestic demand is being observed. Against such continued dovishness we expect another 100bp cut in November. We see the cyclical trough of the policy rate at 15%. However, the risks are for a sharper easing and a higher inflation. On the other hand, the aggressively front-loaded easing cycle increases the risk of a further erosion in credibility that could spill into shifts in portfolio preferences of local investors and – mimicking similar examples in the past – result in a reversal of some of the easing delivered.
JP Morgan