If the appreciation pressure becomes more prominent by the time of the next MPC meeting, the CB will start to respond more aggressively.

Today I would like to address the recent developments concerning the three targets of the Central Bank (CB) and the possible responses to these developments. I would like to stress in advance that I am interested in what the CB “will do” rather than what it “should do.”

The CPI inflation target is 5 percent. I assessed the inflationary outlook during the last commentary. In a nutshell: currently, the CPI inflation rate is quite above the target but close to the average since 2009. But the CB did not announce a revision on the year-end inflation estimation, which is currently 5.3 percent. Hence, we should not expect any response to the inflationary developments in the near future.

Credit growth rate

The second objective is to maintain credit growth rate around 15 percent. Weekly credit growth figures are available for four weeks of January. Calculations based on the CB method reveals annual average credit growth rate for the period at 20.1 percent. The average credit growth rate for the last six weeks is also the same. But going back further in the recent timeframe, six-week averages give a 15 percent credit growth rate. In short, in the last couple of weeks, credit growth rate have been above the targeted level.

Indeed, after the latest Monetary Policy Committee (MPC) meeting, the CB has raised the required reserve ratio slightly in response. So it appears that if the current conditions prevail, which is highly probable, the CB will raise the reserve requirements by a larger rate.

The CB calculates the real value of the lira using the real effective exchange rate (REER) index. A rise in the value of the index implies appreciation in real terms. The CB has declared several times that a rise in the REER above 120 was not desirable. Recent statements reveal that the REER floating between 120 and 125 will bring a mild response. If the index value exceeds 125, the CB response will become gradually stronger.

Last Tuesday, the REER index value for January was released, at 120.2. So, will the CB give any response? To begin with, the index value is almost at the lower limit of the “mild response zone.” Second, this was foreseen and decisions were taken accordingly at the MPC meeting in January: the lower limit of the interest rate corridor was reduced and required reserve ratio for FX loans was raised at some degree. Third, it is getting about that political uncertainty has been rising in Italy and Spain. This, if continues, might affect international risk appetite adversely and ease the upwards pressure on lira. But whether uncertainties will remain is also uncertain.

Mild response to the exchange rate

Taking these three factors into account, we should not expect a significant response to the exchange rate movements in the near future. Even if it does, the response will probably be mild. The CB might raise required reserve ratio on FX deposits at some degree or the reserve options coefficient, for instance. Also, it might slightly reduce the lower limit of the interest rate corridor, but this has slightly smaller possibility. Of course, taking no action might be another option. But if the appreciation pressure becomes more prominent by the time of the next MPC meeting, the CB will start to respond more aggressively.

This commentary was published in Radikal daily on 07.02.2013