KASTAMONU: Turkey's central bank governor set out his case against the sharp cut in interest rates championed by some in government, saying on Thursday it might prompt Turks to hoard dollars and that growth would in any case pick up towards the end of 2014.
The ruling AK Party is keen to maintain its strong record on growth in the run-up to a parliamentary election next June but faces growing headwinds, with the economy slowing more than expected in the second quarter and inflation stubbornly high.
President Tayyip Erdogan, prime minister until last month, has urged sharper rate cuts to spur growth, and Economy Minister Nihat Zeybekci has followed his cue, saying on Thursday that Turkey was "compelled" to grow at least five percent a year.
The tug-of-war over Turkey's economic management has raised concern about divisions within the cabinet, the independence of the central bank, and policy predictability.
Speaking at a conference in the Black Sea town of Kastamonu, Central Bank Governor Erdem Basci said too large a reduction in interest rates would stoke inflation, already running at the upper limit of the bank's forecasts.
"If we were to cut interest rates very sharply, that would prompt citizens to turn from the lira to forex. Foreign investors would also likely act in a similar way. There would therefore be an unwanted upward impact on inflation," he said.
Data on Wednesday showing the Turkish economy grew less than expected in the second quarter increased political pressure on the bank to cut rates further and helped send the lira to its lowest for more than five months.
The lira, stocks and bonds were broadly flat on Thursday.
The current account deficit, Turkey's main economic weakness, is narrowing but is doing so partly on the back of the slower headline growth and one-off effects such as a surge in gold exports, rather than badly needed structural reforms.
It narrowed to $2.63 billion in July, slightly above the $2.5 billion forecast in a Reuters poll.
Basci noted the slowdown in growth in the second quarter but said it was expected to pick up again towards the fourth. The central bank would keep monetary policy tight until there was a significant improvement in the inflation outlook, he said.
Fitch warned on Thursday that the central bank may face growing political pressure to cut rates despite rising inflation if the government pursues populist economic policies in the run-up to the June election.
The agency, which rates Turkey BBB- with a stable outlook, said heightened political risk that negatively affected policy predictability might be a threat to its rating outlook.
"NO BACKWARDS STEP"
The central bank hiked rates sharply in January to defend a tumbling lira, a move it has only gradually been unwinding.
It unexpectedly lowered its overnight lending rate at its last meeting on Aug. 27, a move seen as having little easing impact and intended more as a signal to the government that it is supporting the economy.
The bank had cut its main one-week repo rate by 175 basis points in the three months before that decision, fuelling criticism from some economists that it was caving in to political pressure despite persistently high inflation.
"The rate of loan growth started to come out just as we desired and due to that we were able to cut rates somewhat more. Inflows from abroad, though moderate, began and we were able to make such a cut," Basci told the conference.
"But one has to go carefully. When we take steps they should be solid steps. We have to advance in a way that does not require taking much of a backward step," he said, echoing previous comments that any further rate cuts would be moderate.
The central bank's critics say that stance does not send a strong enough signal on the will to fight inflation and serves only to confuse financial markets.
"What concerns us most (about monetary policy) is something of a disconnect here in the sense that (when) we talk to policy makers ... the clear message is that disinflation is the No. 1 priority," Paul Rawkins, senior director in Fitch's sovereign group, told a conference in Istanbul.
"Yet if you look at policy settings, it's clear interest rates have come down. It does send a pretty confusing message ... it raises issues about central bank credibility, and it raises questions about the duration of economic rebalancing."
Fitch said in a statement that progress towards rebalancing may be more challenging this year, noting looser monetary policy since May, the fragile euro zone recovery and "geopolitical risk" - an apparent reference to wars in the Middle East and Ukraine - could slow the decline in the current account deficit.
Europe is Turkey's main export market while Iraq, which has grown to be its No. 2 single export destination after Germany, has seen demand for Turkish goods slump as violence there rages.
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