Stanford economist [John] Taylor’s Rule is often used by analysts to get a sense of how far from “idealized” monetary policy a given central bank sits by taking into account information conveyed by output gaps, inflation, neutral levels for policy rates and the exchange rate; Taylor’s blog post from last fall approximates the level against which corrective actions should theoretically be taken and I like to think of it as how far ‘behind’ or ‘ahead’ of the curve rates currently sit.  While not a predictor of short-term policy action by any means, it can give insight into whether or not the market might be overly anticipatory of impending action.  Turkey, right now, is a perfect case in point.  New central bank (CBT) governor Erdem Basci’s first meeting last month seemingly extended the Bank’s hitherto dovish efforts to use unorthodox, macro-prudential measures rather than aggressive rate hikes to counteract the G20’s third-fastest growth rate in 2010, holding the policy rate (the one-week repo) at 6.25 percent but lifting the reserve requirement ratio [for foreign and local banks] on one-month lira deposits to 16 from 15 percent, and raising the ratio on FX deposits >1yr to 12 from 11 percent.   This against the backdrop of nominal wage growth (+18%), domestic demand (+25%) and credit growth (30-40%) in 2010 however that has aggravated the country’s deteriorating current account (CA) deficit beyond expectations (9.8% of GDP in March versus 8-8.5% projected) and, per last week’s Economist, will likely “pressure” the government following next month’s election (where AK is likely to win a third term of single-party rule) to “tighten fiscal policy and the central bank to raise interest rates”.   That said the CBT remains firm in its conviction that the economy is suffering the effects of over-borrowing rather than overheating per se, a distinction that should make all the difference to policy watchers and bond holders and makes the latter continued buyers of Turkish debt, especially as many market participants change their paradigm away from hawkish, rate hike expectations (at least near-term 2011; ultimately analysts see a rise to 8.00 percent by Q12012).  To that end, per Taylor’s Rule Turkey remains only slightly behind the curve (~200bp) when aggregating its policy and reserve rates, a function largely of lira appreciation as well as just a slight output gap (symptomatic of its 44% employment rate–the OECD’s lowest) which augments the stance that consumer lending growth is best left tackled through non-rate measures.  The former in particular has played a role in holding down inflation so far, though the CBT revised its inflation forecast for end-2011 to 6.9% (from 5.9% versus a 5.5% target) and consensus forecasts calls for 7-7.5% citing higher oil prices and taxes on textiles.

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